The Rich in Europe Are Poor

Most of the focus of the policy discussion is the income of the poor and working class. As I have written previously, the American working and middle class is economically better off than their European counterpart. The poorest five percent have it better in Sweden compared to Swedish-Americans, whereas all other income groups earn more in the United States.

It is reasonable to focus on the well being of poor as a central measure of fairness and overall well being in a country. However, this focus can go to far, the poor are not the only group in society.

Today I want to discuss a different social group, the currently much maligned top ten percent of income earners. The group includes managers, successful business owners, professionals such as lawyers, doctors, civil engineers and also workers without a college degrees who are very good at what they do.

There are several reasons why we should care about the rich and upper middle classes.

The top percent of income is a non-negligible share of the population whose well being shouldn’t be ignored just because they score low on the victim-hood scale. Keep in mind that the share of the population who will be in the top ten percent at some point in their life-cycle is much higher than ten percent. The right over-exploits this argument (obviously not everyone has an equal chance of becoming rich, and many in society have close to zero opportunity). However the completely static view of the left is also an exaggeration.

More importantly, creating an environment where the most productive in society have incentives to acquire a lot of human capital, work hard, put their carrier ahead of leisure, work intensively and if necessary with unrewarding tasks, take risks and aim for the top is good also for everybody else.

* The more the high-skilled earn, the more we can tax them and fund welfare for the poor. According to the OECD, the top ten percent of American income earners pay 45% of taxes (this includes payroll taxes). In Sweden, the corresponding figure is only 27%, and fin France 28% . Wouldn’t ordinary Swedes be better off if our most talented worked more and paid more taxes?

* When you put a lot of skilled people together in knowledge industries and entice them to work hard, productivity appears to go up exponentially. This is what we observe in cities such as New York, and in elite organizations such as Mckinsey, Google or Harvard. These high-skilled individuals and organizations create a great deal of so-called innovation spillovers. The people who developed the microprocessor thus only captured a small fraction of the societal value created as private wealth. This is one reason I believe the standard estimates underestimate the negative effects of taxes on the economy, since they neither include innovation and knowledge spillovers or the effect skilled people have on the productivity of other skilled people.

* The high-skilled likely not only raise the productivity of each other, but also of the rest of society. When someone created a new venture he or she raises the productivity of the people hired. Similarly good managers are needed for companies to be productive.

* Lastly the high-income raise the wages of the poor by bidding up demand for their labor. Thus busboys in the U.S earn much more than busboys in El-Salvador, even if they perform the exact same task. The left tends to become angry whenever you point this out, although I have never seem them offer any arguments why this simple implication of economics doesn’t hold.

Needless to say, raising the labor supply of the high-skilled generally does not imply theft from the poor. If a doctor or civil engineer postpones retirement for one year and earns more, that reflects more value created, not exploitation. There are examples when the high-skilled earn “rents” rather than create value (such as many lobbyist) or engage in zero-sum activity (some but far from all people in finance), but this is a minority of overall economic output of the professional classes.

We should be honest and admit that skilled professionals contribute more to society than the bottom ten percent. However I also believe that those at the top tend to have had a more privileged life and hence should feel a stronger social obligation.

In would guess that the behavior of the top ten percent is one of the most important reasons for the success of the U.S economy compared to that of Europe. Highly skilled Americans work crazy hours, are professional and motivated, and tend to be quite good at what they do. Probably mainly due to lower taxes and a better business climate, the top ten percent earn far more in the United States than in Europe.

An exciting new database by economists Facundo Alvaredo, Tony Atkinson, Thomas Piketty and Emmanuel Saez amongst others has data on the income level of the tenth percentile for several countries. This measure, P90, is the level of income that would make someone richer than exactly 90% of the population.

I have adjusted the figures for inflation and PPP based on OECD data. For a couple of countries the data was a few years prior to 2005, so I assumed their income share remained constant and their income increased with GDP.

These are not perfect estimates, because the data comes from different sources, have different units and different standards, you should just view them as illustrative. These are pre-tax income. Payroll taxes are not included, nor is employer funded benefits such as health insurance and pensions. These are mainly based on the statistics gathered by the tax-agency, so unreported income will not be included.

In 2005 the P90 threshold in the United States was $105.000, which means that ten percent of Americans had income at or above that level.

The same year the P90 threshold in Sweden was $43.000 (37700 kr), so if you earned this paltry sum you were among the top ten percent highest earners. In fact, less than 1 percent of Swedes earn more than $100.000 per year, about 880.000 kronor per year purchasing power adjusted.

This is confirmed by the Swedish Statistical Agency, which reports that in 2005 there were 61.000 Swedes who earned more than 800.000 kronor per year, or merely 0.8% of the adult population. 10.2% earned more than 360.000 kr, which confirms that the figures are almost identical to the Top Income Database.

No doubt, those at the bottom are better off in Sweden than in the United States. However the middle class in Sweden is still somewhat poorer than the middle class in the United States, while high-skilled Swedes are far poorer than high-skilled Americans.

I don’t think having few poor people requires us to keep the rich down. The left considers the relative poverty of the top earners in Sweden a good thing for Sweden, while I believe it is a problem. The comparative poverty of the rich is problematic both from the perspective of those hired by entrepreneurs, those who benefit from new technologies and products developed by skilled workers, those who sell their goods and services to the rich and not the least from the perspective of tax collection and the welfare state.

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