IZA DP No. 8157 Long-Run Trends in the Distribution of Income and Wealth Jesper Roine Daniel Waldenström April 2014 DISCUSSION PAPER SERIES Forschungsinstitut zur Zukunft der Arbeit Institute for the Study of Labor Long-Run Trends in the Distribution of Income and Wealth Jesper Roine SITE, Stockholm School of Economics and IZA Daniel Waldenström Uppsala University and IZA Discussion Paper No. 8157 April 2014 IZA P.O. Box 7240 53072 Bonn Germany Phone: +49-228-3894-0 Fax: +49-228-3894-180 E-mail: [email protected] Any opinions expressed here are those of the author(s) and not those of IZA. Research published in this series may include views on policy, but the institute itself takes no institutional policy positions. The IZA research network is committed to the IZA Guiding Principles of Research Integrity. The Institute for the Study of Labor (IZA) in Bonn is a local and virtual international research center and a place of communication between science, politics and business. IZA is an independent nonprofit organization supported by Deutsche Post Foundation. The center is associated with the University of Bonn and offers a stimulating research environment through its international network, workshops and conferences, data service, project support, research visits and doctoral program. IZA engages in (i) original and internationally competitive research in all fields of labor economics, (ii) development of policy concepts, and (iii) dissemination of research results and concepts to the interested public. IZA Discussion Papers often represent preliminary work and are circulated to encourage discussion. Citation of such a paper should account for its provisional character. A revised version may be available directly from the author. IZA Discussion Paper No. 8157 April 2014 ABSTRACT Long-Run Trends in the Distribution of Income and Wealth* This paper reviews the long run developments in the distribution of personal income and wealth. It also discusses suggested explanations for the observed patterns. We try to answer questions such as: What do we know, and how do we know, about the distribution of income and wealth over time? Are there common trends across countries or over the path of development? How do the facts relate to proposed theories about changes in inequality? We present the main inequality trends, in some cases starting as early as in the late eighteenth century, combining previous research with recent findings in the so-called top income literature and new evidence on wealth concentration. The picture that emerges shows that inequality was historically high almost everywhere at the beginning of the twentieth century. In some countries this situation was preceded by increasing concentration, but in most cases inequality seems to have been relatively constant at a high level in the nineteenth century. Over the twentieth century inequality decreased almost everywhere for the first 80 years, largely due to decreasing wealth concentration and decreasing capital incomes in the top of the distribution. Thereafter trends are more divergent across countries and also different across income and wealth distributions. Econometric evidence over the long run suggests that top shares increase in periods of above average growth while democracy and high marginal tax rates are associated with lower top shares. JEL Classification: D31, H2, J3, N3 Keywords: income inequality, income distribution, wealth distribution, economic history, top incomes, welfare state, taxation Corresponding author: Daniel Waldenström Department of Economics Uppsala University P.O. Box 513 751 20, Uppsala Sweden E-mail: [email protected] * Forthcoming as a chapter in: Atkinson, A.B., Bourguignon, F. (Eds.), Handbook of Income Distribution, Vol. 2, North-Holland, Amsterdam. We have received valuable comments from Anthony Atkinson and seminar participants at the conference “Re-cent Advances in the Economics of Income Distribution” held at the Paris School of Economics, April, 2013. We thank Wiemer Salverda for sharing wealth distribution data on the Netherlands. Data underlying all graphs and tables in the chapter are available on the authors’ websites or upon request. Table of contents 1. Introduction .................................................................................................................................................... 3 1.1 From the Kuznets series, to household surveys, and back again ........................................................... 3 1.2 Outline of the chapter ............................................................................................................................ 6 1.2.1 Top income shares and other measures of long run income inequality .......................................... 6 1.2.2 Long-run trends in the wealth distribution ..................................................................................... 7 1.2.3 Searching for explanations ............................................................................................................. 8 1.3 What is this chapter not about? .............................................................................................................. 9 2. Long run trends in income inequality ............................................................................................................11 2.1 Methods and data in the top income literature ......................................................................................13 2.1.1 Tax statistics and the definition of income ................................................................................... 13 2.1.2 Reference total for the population ................................................................................................ 16 2.1.3 Reference total for income ........................................................................................................... 17 2.1.4 Interpolation techniques and the interpretation of the Pareto coefficient ..................................... 18 2.1.5 Tax avoidance and tax evasion ..................................................................................................... 20 2.1.6 Other issues .................................................................................................................................. 22 2.1.7 So can we trust the top income data? ........................................................................................... 22 2.2 The evidence and what we learn ...........................................................................................................23 2.2.1 Common trends or separate experiences? .................................................................................... 23 2.2.2 The importance of developments within the top decile ................................................................ 26 2.2.3 The importance of capital incomes and capital gains ................................................................... 27 2.3 The relation between top income data and other measures of inequality .............................................31 2.3.1 Comparing tax-based and survey-based estimates of top income shares ..................................... 31 2.3.2 Theoretical and empirical relationship between top shares and overall inequality measures ....... 32 2.3.3 Other series over long run inequality: wages, factor prices and life prospects ............................. 34 2.4 Income inequality over the long run – Taking stock of what we know ................................................38 3. Long run trends in wealth inequality .............................................................................................................40 3.1 Data and measurement..........................................................................................................................40 3.1.1 The wealth holding unit ................................................................................................................ 41 3.1.2 The concept of wealth .................................................................................................................. 42 3.1.3 Measuring historical wealth inequality ........................................................................................ 46 3.1.4 Tax avoidance and evasion........................................................................................................... 48 3.2 Evidence on long run trends in wealth inequality .................................................................................49 3.2.1 Country specific evidence ............................................................................................................ 49 3.2.2 Cross-country trends in long-run wealth concentration................................................................ 67 3.3 The composition of wealth ...................................................................................................................69 3.4 Concluding discussion: What do the long run wealth inequality trends tell us? ...................................71 4. Determinants of long run trends in inequality ...............................................................................................73 4.1 A first look at inequality trends, structural changes and shocks ...........................................................74 4.1.1 What about the Kuznets curve? .................................................................................................... 78 4.2 Combining wage earnings