In this post, I’m going to celebrate an anniversary of sorts. It’s been 4 years since I stumbled on a striking relation between inequality and capitalist income. In the United States, the income share of the top 1% is tightly related to the share of corporate dividends in national income.
Over the last four years, I’ve developed a model that explains this relation. I won’t talk about the model here, but regular readers of this blog will be unsurprised that the model is about hierarchy. I’ll go over this model in future posts. If you’re interested, the model paper is here.
Anyway, I hope you enjoy this repost. I’m proud of discovering this relation between inequality and dividends. A question for the future — does it extend to other countries?
Inequality and Capitalist Income
For a long time now I’ve been bothered by the lack of a clear connection between capitalist income and inequality. I’ve always thought that the connection should be straightforward: since the vast majority of capitalist income (interest and profit) flows to wealthy individuals, it follows that an increase in the capitalist income share ought to lead to an increased income share of the wealthiest individuals.
Unfortunately, this simple logic is not supported by empirical evidence. Using data from the US, there is no significant relation between capitalist share of national income and the income share of the top 1%. Even if we disaggregate profit and interest and compare them to income inequality, there is still no significant correlation.
I’m not sure why it took me so long to realize this, but last week I realized that corporate profits are not really a type of personal income. Simply because a corporation earns a profit, does not mean that any individual necessarily gets to count this money as income. Only when profits are paid out as dividends do they become a source of personal income. Therefore, if we want to connect capitalist income to inequality, we ought to look at dividends as a share of national income. This removes from the equation profits that are taken by the government (as tax) and profits that are reinvested by the company.
The resulting relation between dividends and income inequality jumps off the page. As the figure below demonstrates, the two series are highly correlated.
It appears that the size of corporate profits has no bearing on income inequality. Rather, it is the composition of this profit that matters. When companies reinvest most of their profits, income inequality is low. Conversely when companies pay out most of their profits as dividends, income inequality is high.