On the Distribution of Wealth
“Both Social Security and Medicare face long-term financing shortfalls under currently scheduled benefits and financing. […] The Trustees recommend that lawmakers take action sooner rather than later to address these shortfalls […to] minimize adverse impacts on vulnerable populations ….” Social Security and Medicare Boards of Trustees, Message to the Public, 2017
Scholars who examine the distribution of income often focus on the issue of poverty. From this perspective, one of the great achievements of our time is the extraordinary reduction of extreme poverty worldwide.
In an effort to understand the dynamics of the distribution of income and wealth, over the past decade, there has been an explosion of research, including the construction of historical measures for a wide range of countries (see, for example, the World Inequality Database). While important debates about measurement and data interpretation continue, a range of evidence points to two important conclusions. First, over the past two centuries, the global income distribution has become far more equal. But, while the gap between countries is now much smaller, in recent decades, inequality within some advanced countries, especially in the United States, has risen.
People study inequality because of their interest in welfare: their chief concern frequently is that larger disparities in the well-being of people within a society will pose greater challenges for those most vulnerable. This objective encourages economists to shift their focus from the inequality of income to that of consumption. Not only is consumption more closely linked to well-being, but it also incorporates the impact of transfers and in-kind compensation that some measures of income miss. As it turns out, however, in the United States in recent decades, the two trends appear to move together (see, for example, Attanasio and Pistaferri). Similarly, Chetty et al highlight the enduring association in the United States between the inequality of income and that of life expectancy.
Rather than income or consumption, in this post we focus on the distribution of wealth. Wealth affects welfare in at least two key ways. First, in the presence of borrowing constraints, it provides a buffer against fluctuations of income, allowing households to smooth consumption in the face of temporary bouts of illness or unemployment. Second, it provides the basis for household spending in retirement. With populations aging in many advanced economies (and soon in China), the role of wealth as a retirement buffer is becoming increasingly important.
As we will see, the distribution of wealth is far less equal than that of income. Moreover, recent research shows that, following the Great Financial Crisis (GFC) of 2007-2009, the U.S. wealth distribution has become decidedly more unequal. As a result, a large portion of U.S. households appear to have little scope for meeting retirement needs out of their current net worth, making federal insurance programs (that include an element of redistribution) key to their future well-being.
Turning to some data, let’s start with a comparison of income and wealth inequality in the United States. Based on the Federal Reserve’s triennial Survey of Consumer Finances (SCF), the gap between the shares at the top and the bottom of the distribution is persistently larger for wealth than for income (see chart; tax-based measures also show a sustained gap). Not only that, but the difference has grown over time. Specifically, for the most recent 2016 survey, the wealth of the top 10% of households (ranked by wealth) is 65 times that of the bottom 50%, up from 23 times in 1989. The comparable multiples for income were 3.3 in 2016 and 2.5 in 1989.
Shares of Wealth and Income in the United States (Percent), 1989-2016
Source: Based on table 4 of Kuhn, Schularick and Steins including a 2016 update kindly provided by these authors.
While wealth inequality prevails virtually everywhere in modern economies, the differences across countries are large. Among the advanced economies, wealth inequality appears particularly pronounced in the United States (see the next chart). According to OECD data, the United States ranks at the top for the wealth shares of the top 10% (79.5%; gray bars) and the top 1% (42.5%; red circles). It is also the third lowest for the bottom 60% (2.4%; blue diamonds). At the opposite end of the spectrum is Japan, where the wealth ratio of the top 10% to the bottom 60% is 2.3, just a fraction of the U.S. ratio of 33.
Shares of Wealth by Country, Latest Available Data
Source: OECD wealth distribution database. The latest data range from 2016 (United States) to 2012 (Canada, Norway and Spain).
What factors influence the evolution of the wealth distribution in the United States? One element is the path of incomes. Looking back at the first chart, note that the Fed’s survey measure of income has grown more slowly for those at the lower end of the distribution. Other things equal, slower income growth means less saving and less wealth accumulation. Moreover, the lower the mobility of people between income groups over generations, the wider the gap between the savings and wealth paths of the wealthy and those of the others (see, for example, Chetty et al). A second factor is that the less well-off hold a different mix of assets and are more reliant on leverage. A third reason for increased wealth inequality is the evolution of asset prices themselves.
What are the key portfolio and leverage differences across the population? The wealthiest Americans invest the largest portion of their wealth in business equity and related instruments, while people in the middle of the distribution concentrate their holdings in a highly undiversified asset—their home (see the next chart). Based on the latest SCF, 80.4% of the assets held by the top 1% are composed of corporate stock, unincorporated business equity, financial securities, mutual funds shares, personal trusts, and real estate other than their primary residence (see chart and Wolff, Table 7). In sharp contrast, for those in the middle three quintiles of the distribution (that is, from the 20th to the 80th percentiles), their principal residence accounts for 61.9% of their assets. The two groups also have sharply different levels of leverage: relative to net worth, debt is an almost imperceptible 2.4% for the top 1%, but comes in at a whopping 58.9% for the middle 60%. Most of the latter is mortgage debt (see Wolff, Table 8).
United States: Portfolio shares and leverage by wealth group, 2016
Note: The numbers shown in black are wealth shares, while those in blue are leverage ratios. Source: Based on table 7 of Wolff.
Despite relatively sluggish income gains at the bottom of the distribution, the general rise of asset prices in the decades prior to 2007 boosted wealth across the board (see the following chart). However, as Kuhn, Schularick and Steins (KSS) highlight, the collapse of housing prices during the GFC triggered a large setback for those below the top 10%. In contrast, the post-crisis recovery of stock prices sharply boosted the wealth of those at the top.
U.S. household net worth by wealth groups (trillions of 2016 U.S. dollars), 1950-2016
Note: Each bar (as well as its red data label) shows the aggregate net worth of households and nonprofits in trillions of 2016 U.S. dollars, using the end-year CPI as the deflator. The KSS wealth shares are used to decompose the ownership by wealth group, with the holdings of the bottom 50% shown in black, as well as in the rectangles. Those of the top 10% are shown by the gray-shaded regions. Sources: Table 4 of Kuhn, Schularick and Steins (including a 2016 update kindly provided by these authors), Financial Accounts of the United States and the Bureau of Labor Statistics.
Applying the KSS shares (based on the SCF) to the level of household net worth from the Financial Accounts, we come to the following conclusions. While aggregate net worth rose by 20% from 2007 to 2016, the wealth of the top 10% rose by nearly 30%. Over the same period, the wealth of the bottom 50% plunged by more than 40%. Looking per household, the drop is even larger, more than 50%. Over a longer interval, the results also are startling: per-household wealth in the bottom half of the distribution is not only lower today than it was in 2007, but it is substantially below the level in either 1971 or 1989.
Returning to welfare, the recent dramatic increase in wealth inequality has two important implications. First, most households have less capacity to smooth their consumption when faced with transitory income shocks. As a result, there is a risk that recessions will be both deeper and more harmful to the most vulnerable in society.
Second, just as the retirement of the baby boom generation shifts into full swing, tens of millions of U.S. households may have little or no net worth on which to fall back. Absent a sharp and sudden climb in housing prices, it will be difficult for those in the bottom half of the wealth distribution who are currently approaching retirement age to maintain a decent standard of living after leaving the workforce. Many of those who can delay retirement probably will feel compelled to do so, even if their wages stagnate or slide. Those who cannot delay will be even more reliant on government-provided pension and health care in the form of Social Security, Medicare and Medicaid.
Acknowledgement: We thank our friend and colleague, Moritz Schularick, for valuable discussions and suggestions.