Why Economists Ignore Much of Rich People’s Income

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By Steve Roth

The standard definition of income makes much of rich people’s income invisible.

If your home or stock-portfolio value goes up over a decade or three, have you received “income”? It sure as heck feels like income. It increases your asset holdings and net worth. It’s new money in your pocket that you can spend now and in your retirement. (Maybe you have to sell things or borrow against them. Whatever.) How is that not income?

But in economics — actually right down to the core of national accounting methods — capital gains aren’t counted as income. And they don’t contribute to “saving.” Those gains are completely invisible to a huge bulk of the economics work (both empirical and theoretical) that is built on income and saving concepts and measures.

Even Piketty and company, who importantly include capital gains income in their income data, don’t include it in their theorizing about income and saving. Ditto most Modern Monetary Theory (MMT) work, despite (or because of?) that group’s rigorous accounting-based approach.

There’s a historical reason: When FDR tasked Simon Kuznets and his cohorts to create the National Income and Product Accounts (NIPAs) in the 1930s, they had no means to measure or estimate people’s assets, net worth, “wealth.” (The NIPAs didn’t have balance sheets, and still don’t. Cap gains don’t, can’t, exist in the NIPAs.) So they built incomplete accounting constructs that they called “Income” and “Saving,” that they could estimate based on measurable flows within the accounting period.

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Those incomplete constructs shamble on today in the Fed’s Flow of Funds matrix. It’s a closed-loop accounting construct that’s only closed because it balances to an artificial and incomplete balancing item called “Saving” (based on the incomplete definition of income). The Flow of Funds don’t sum to change in net worth — the very “balance” in “balance sheets.” Because cap gains are missing.*

Theory: The justification is that income is payments to “factors of production” — labor, capital, natural resources, etc. But think about it: when existing-asset markets go up, that’s the market looking at our previously created assets and “realizing” they’re worth more than they thought they were at the time of production and sale. So cap gains are delivering income from production — production in previous periods.

Data: Capital gains comprise 15-25% of comprehensive household income (it varies a lot year to year).

Distribution estimates vary, but some are eye-popping: as much as 96% of capital gains income may go to those making more than a million dollars a year.

In 2011, the top 1% of U. S. earners (median income, $1.4 million) got 36% of their income from capital gains — all invisible in the standard measure of “income.” This is only realized capital gains, of course, and it ignores capital gains from the $20-trillion+ of invisible assets held in offshore tax havens.

Politics: by rendering capital gains income largely invisible to accounting, these incomplete income and saving measures make those flows largely invisible to economists, and hence to politicians, and to the whole political conversation about equality and distribution.

It’s darned hard to understand how income and saving work in economies if you’re ignoring 15–25% of households’ income and saving.

It’s not hard to guess which group benefits from that incomplete discussion.

* For accounting dweebs: The Flow of Funds Matrix (pages 1 and 2 of the Fed’s quarterly Z.1 report) ignores the Revaluation and Other Changes in Volume accounts, which you’ll find in the Z.1’s Table S.3.a, and in the Integrated Macroeconomic Accounts of the United States (the IMAs) — both based on the modern international System of National Accounts (SNAs). For an explanation of this comprehensive, mark-to-market, capital-gains-inclusive income accounting, see Haig-Simons accounting. See also discussions of Haig-Simons in Godley and Lavoie’s Monetary Economics.

2016 January 25

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  • Rupertborn

    How can anyone hope to measure this stuff? Seems really cumbersome and intrusive. The post is “Why Economists Ignore Much of Rich People’s Income” but it seems clear that the answer is that there would be a tax revolt if they tried to pry that deep. What am I missing here?

    • David Whitlock

      There would only be a “revolt” because wealthy (and selfish) people have structured their assets (and the accounting and tax industries) so as to play this “game” and “hide” their real income so it won’t be taxed.

    • Bongstar420


      You forget about FDR tax rates. I presume your supposed to though

  • rustysaint

    Many of the unrealized capital gains are in real estate values – very hard to pin down unless there is an annual appraisal (an expensive process). And even then, there is a good deal of subjective guessing as to the value of the property.

    • Bongstar420

      Many assets would be worthless in a true economic crash

  • Dariel Garner

    Not only is unrealized gain or loss on assets not recognized, it is not taxed. Utilizing trusts, foundations, off-shore vehicles, the gain may never be taxed which helps to create the dynastic wealth that we see forming today. Creating a system of taxation based on constant reappraisal is possible. Many of us forget that modern accountancy owes much of its existence to the need for income tax reporting, the same would be true for a growth in the appraisal profession.

    The political possibility of a wealth tax will be dependent upon the wealthy finding their needs are best met by a stable, nonviolent populace that is cared for. And it will be dependent upon the people organizing and moving to claim their rights as humans to the wealth common to all.

  • davidcayjohnston

    While I am delighted that Steve Roth is focusing attention on the mismeasures of our federal income and (very limited) wealth statistics, there is one troubling misconception Roth perpetuates concerning the 1 percent.

    Roth wrote:

    “In 2011, the top 1% of U. S. earners (median income, $1.4 million) got 36% of their income from capital gains — all invisible in the standard measure of “income.” This is only realized capital gains, of course, and it ignores capital gains from the $20-trillion+ of invisible assets held in offshore tax havens.”

    First, thanks for using the accurate estimate of offshore wealth by Jim Henry and not being duped into the much smaller measure, about $7 trillion, by economist Gabriel Zucman that was embraced at Davos and even by the usually excellent New York Review of Books.

    What is terribly misleading is treating the 1% as a cohesive group when it is not, as my books Perfectly Legal and Free Lunch explain.

    A third of all capital gains captured by the tax system go to the 10,000 tax households (out of ~160 million) with adjusted gross income of $10 million or more.

    Among the 1 percent in 2011, Roth’s chosen year, half made less than $553,000. The vast majority of their income was from labor, albeit very well paid work mostly by professionals and managers.

    For those making $500,000 to $1 million that year capital gains were just 5 percent of income, far from the 36% figure that Roth cites. (That 5% is now closer to 10% because of the rising stock market during the Obama years.)

    For half of the 1% income is overwhelmingly from labor, not capital. Never mix the bottom half of this group with the top tenth and above or you mislead.

    The data are also skewed by the fact that Congress lets the super rich borrow against their assets and show little or no income, as I have explained repeatedly. The official data miss, for example, hedge fund and private equity fund billionaires who can legally defer reporting almost all of their income for decades, a huge stealth subsidy.

    We need to keep the record clear that it is the top 1/10th of one percent and above who reap the significant benefits of capital incomes and rising stock values that the tax system captures erratically. The best off 1-in-1,000 have seen their share of total income grow since 1979 and now command almost as much income as the bottom 50%. If we had better measures, the official data would surely show that the top tenth of one percent make even more than the bottom half.

    Save for this flaw, this is one of the best pieces I have ever read about explaining the mismeasures and misunderstandings about income and wealth disparities.

    • David, thanks for the comment (and the very kind compliment!). Some difficulty in play here between realized and mark-to-market/accrued cap gains. (Your point exactly: if you’ve accrued you can borrow against it and spend — or just spend a larger percentage of your “regular” income than you would otherwise — without selling/realizing. IOW you can spend more while maintaining your net worth. Cap gains are income!)

      Just one example of this conundrum: The Survey of Consumer Finances suggests that cap gains are a much smaller percentage of rich people’s income than the Z.1/IMAs as shown in the graph here — SCF generally in the high single digits. Leads one to wonder what cap gains survey respondents are reporting. Z.1/IMAs are reporting accrued/mark-to-market gains.

    • Bongstar420

      There are 1,500 billionaires on the planet
      There are 200,000 people with 150 IQ’s on the planet
      The average IQ of billionaires is around 115

  • “How is that not income?”

    Because to spend it you have to take savings off somebody else by transferring the asset. So overall in aggregate it isn’t income. At best it’s collateral for other flowing funds elsewhere.

    The pension myth is the classic one. You don’t actually save for a pension. What you do when you draw a pension is obtain the pension savings of somebody else who is currently saving for a pension. It’s just a transfer. A private taxation transaction. In fact internally within a pension fund you can see that in the accounts – however it is calculated or accounted for, your pension in payment is just other people’s pensions savings plus whatever income comes from the assets, if any.

    When you’re saving for a pension you’re just paying for today’s pensioners. And a few tokens are transferred and numbers invented to make it feel like you’re creating something. But you’re not really.

    Capital gains is just an illusion. If you get a rush of people trying to use them, then they disappear as surely as the wind erases your reflection in a pond.

    The appearance of apparently permanent capital gains essentially arises as a function of the increase in private debt – since that is what turns collateral into a spending flow. There is no ‘realisation’ about them. It forced upwards by the sheer weight of money.

    Endogenous money strikes again.

    • Emmef

      Endogenous money feeds inflation which drives up the price of assets. Even though they might not be easy to “spend”, it will make it more difficult though for others to obtain them, which can be a problem if we’re dealing with land or buildings that are necessary to live or produce stuff. Except hat credit (debt/endogenous money) is “cheap” and closes the circle. This is even without the positive feedback loop in the amount of debt banks may create …

      How to break the circle without a revolt?

      • Bongstar420

        Inflation is caused by people raising prices when they see consumption go up

        • Emmef

          The textbook example you mention is not invalid, but just one of the reasons and not the one single reason. Economists generally ignore endogenous Money and that is a shame, as it breaks all the models they work with.

    • There’s $100 trillion in household assets, $80 trillion in net worth.

      The stock market goes up because people realize the firms’ assets (produced in previous periods) are worth more than they thought — that they’ll deliver more human value than had been thought.

      There’s $110 trillion in assets, $90 trillion in net worth.

      Money, created ab nihilo, with no additional debt issuance. Got endogenous? I think this is what’s invisible to inside-the-FOFAs thinking, where Starting NW + Saving ≠ Ending NW.

      • “The stock market goes up because people realize the firms’ assets (produced in previous periods) are worth more than they thought — that they’ll deliver more human value than had been thought.”

        It goes up simply because there is increasingly more money chasing not enough stocks.

        There’s no realisation in it at all. Go do the fundamental analysis on Facebook etc. Much of the ‘value’ there is justified by handwaving. People post-hoc justifying why it is a great company. Same with Amazon and all the rest of them.

        However if you simply see them as repositories of the circulation created by excessive issuing of private debt then the price of them is explained more easily. There is too much financial saving and it doesn’t know what to do with itself. So you end up in greater fool territory.

        Again you can only spend this ‘money’ by liquidating it. And since there is no market maker of last resort, you have no guarantee you can. Which is what makes it something else other than money.

        Bitcoin is another example of the phenomenon.

        • Bongstar420

          Value is mostly subjective. You might not value facebook, but a bunch of commoners do. And they got more stuff than you

    • Kaleberg

      It’s not just the pension myth. Every society has some mechanism for providing goods and services for older people who are no longer efficient workers themselves. It may be explicitly sanctioned, subject to family or tribal custom, or justified by some economic mysticism. Pensions, savings, social security are just excuses for providing older people with goods and services provided and produced by younger people. Money is as good a way of accounting for this as any.

      • It is, but that can be done from flow – as in a State Earnings Related Pension, rather than having thousands and thousands of people shuffling numbers backwards and forward for no good reason.

        Doing it via ‘pots’ is a very inefficient way of providing a pension – and quite unfair as well.

        • Bongstar420

          Or people could be good lil commies and just do it because it needs doing.

    • jayrayspicer

      “Because to spend it you have to take savings off somebody else by
      transferring the asset. So overall in aggregate it isn’t income.”

      And that’s different from selling something out of inventory for a profit how? Inventory is an asset. The purchase price is deducted from somebody else’s savings. The difference between cost and price of an inventory item is income, yes? Why isn’t the difference between purchase cost and selling price of a share of stock income?

      • You didn’t produce the share at any point. Inventory is just an accounting carry over system over periods. It didn’t just pop into being because you made a couple of entries on a ledger. Production was caused by the flow at some point – and incurred a real cost. And real production is the point of an economy. The magic of an economy that makes it non-zero sum is triggering that creation constantly. It’s that what makes income income.

        Shuffling financial instruments around doesn’t really create anything of use. So it becomes a zero sum operation. And that is just savings shuffling.

        • jayrayspicer

          Neil, if I run a retail business, then I didn’t produce the inventory item, either. I bought it. And then I sold it at a profit. A profit to me. Income to me. Again, how is purchasing and selling a share of stock at a personal profit any different from buying and selling an inventory item? It doesn’t matter whether the thing in question is worth more because you’re covering shipping, merchandising, and warehousing costs, or because the company behind the stock has increased in value because of value added to products or services, or the stock price has inflated because of money flowing into the stock market from somewhere else. What matters is that I made a profit and I should pay income tax on that income. Acquiring more money by buying and selling assets (or your labor) is what makes income income. It’s the definition of income.

          Sounds like you’re talking about what sets a stock price vs what creates wealth, not what counts as income. Or maybe what should and should not count as income for purposes of calculating the actual growth of an economy. I certainly agree that GDP is a nonsensical measure, and stock prices are only partially representative of corporate value, but let’s not confuse terms.

          • Try thinking wider than just you. The point of an economy is to produce something. Overstocking a shop just causes production halts further down the line as the orders dry up. And you are breaking out as part of the distribution chain. The value a shop adds is bulk order to individual distribution. That’s the value that eventually generates the profit that is taxed. And it uses up people, and plant to do undertake that process.

            Selling a share is simply moving it elsewhere swapping financial savings around. Whether it goes up or down is more to do with the way the wind is blowing that anything else. You’ve added nothing to the process by doing it and used up no real resources in doing so.

            Only flow that uses up real resources needs taxing – because only real resources are in short supply. That is the primary reason for having taxation – freeing up real resources for the public purpose. The shuffling in the financial sphere is just a distributional issue.

            The question is why there are capital gains at all and whether an economy based upon artificially inflating asset prices to try and get people to borrow money from banks is really a sensible system.

          • jayrayspicer

            I’m pretty sure the point of an economy is to distribute somethings, not produce somethings. Broader and more efficient distribution leads to additional production, but production will happen in the complete absence of a functioning economy, else everyone would starve.

            I didn’t say anything about overstocking. And yes, bulk purchasing is part of the value added by retail, but retail produces nothing. It is entirely about distribution. So again, if it’s inappropriate to tax capital gains, it’s inappropriate to tax retail income.

            The person holding a share of stock doesn’t add any value to that share by holding it, apart from the time value of money (which is pretty much the definition of capitalism–letting somebody else use your capital in exchange for a share of the profits). And while various things can affect a stock price, increases in wealth produced by the issuing company are also recognized in stock price increases; it’s not just about cash inflows to stock markets.

            Regardless, “only flow that uses up real resources needs taxing” is an extremely dubious blue sky assertion. Taxes are levied for lots of reasons, though obviously filling the public coffers is necessary. But if we agree to tax income, then capital gains is *clearly* income. You have to work pretty hard to convince yourself that it isn’t. You haven’t really even tried to convince me. Even if the aggregate net capital gain in the economy is partially offset by capital losses, the bulk of it represents wealth added to the economy by labor (production). The only argument against taxing capital gains is that it discourages investment. I don’t agree with this argument. People will invest their excess capital no matter how it gets taxed. What else are they going to do with it?

            In the interests of fairness, capital gains should be taxed as regular income. Partly because it *is* regular income, and partly because it’s unreasonable to tax wage income at a higher rate than investment income. Wages are hard earned, requiring a large time investment that makes it hard to do anything else with your life. Investment income is easy money. You literally don’t have to work for it, because somebody else is doing that.

            You can certainly argue that income should not be taxed, perhaps as an inducement to hiring and working for a living. But taxation is largely a matter of picking your poison. Would it be better to tax wealth? People don’t much like that, partly because wealth is usually not that liquid. A sales tax? A VAT? Both are a drag on the economy, and the sales tax is particularly regressive. Taxing income allows a progressive approach, which is fair because those earning more are benefiting more from the economy that their taxes support; it’s essentially a nonspecific use tax. Taxing capital gains keeps the economy from overheating and partially redresses the unfairness of investor class easy money.

            I suspect that neither one of us will be rewarded anytime soon with a change to the tax code reflecting our point of view, whether 0% capital gains tax, or capital gains taxed as regular income. But if you want to talk about how to measure the overall economy, then talk about that. If you want to talk about how, why, and whether to tax income, then talk about that. But don’t confuse the two. Income is *always* defined from the perspective of the entity receiving the income. The directionality is right there in the word. An income tax should tax income unless there’s a compelling reason to treat one type of income differently than other kinds. I see no such distinction with capital gains income. Empirically, the different tax treatment enjoyed by capital gains doesn’t seem to have had the trickle-down effect that was hoped. We should stop the experiment. Increasing the capital gains tax break to 100% would be throwing good money after bad.

          • “but retail produces nothing.”

            It produces a distribution using real people and real goods. That distribution is real effort for which the entity organising it earns a living. That is production of real output. Production is more than just bashing metal.

            I’ll say it again – it is the use of real people and real goods that is the primary reason to tax – because running out of real goods and real people is what causes inflation.

            If your distribution system is working effectively, then there is no other reason to tax.

            And this is not an argument against taxation or taxing capital gains when realised (which should then just be treated as any other earnings rather than having special tax rates and allowances). It is whether changing prices of assets should be treated as income conceptually even though there is no mechanism to spend them.

            Most people don’t care what their house is worth this year, or their car. They just use them. Somebody on a low income in a house that appreciates massively just because of macro stupidity could not afford an annual tax charge without being forced out of their home. And that is unfair. They did nothing that deserves such a fate.

            Income is taxed primarily to reduce the capacity to spend and cause inflation. That is the purpose of the taxation. If there is no mechanism to spend, then you don’t need to tax.

          • Bongstar420

            There you have it…but that “product” is still less valuable than the manufacturer because its easier to sell stuff then produce it.

          • Bongstar420

            You do realize its insulting to people to make a point which assumes that most people do not earn a living

    • Bongstar420

      I would say a profit is a transfer…someone must get paid less or must pay more than the value for someone else to profit

  • seanage

    I’m sorry but I’m totally confused.

    “In the United States of America, individuals and corporations pay U.S. federal income tax on the net total of all their capital gains just as they do on other sorts of income. “Long term” capital gains are generally taxed at a preferential rate in comparison to ordinary income.[1] The amount an investor is taxed depends on both his or her tax bracket, and the amount of time the investment was held before being sold.

    Short-term capital gains are taxed at the investor’s ordinary income tax rate and are defined as investments held for a year or less before being sold. Long-term capital gains, which are gains on dispositions of assets held for more than one year, are taxed at a lower rate than short-term gains. In 2003, this rate was reduced to 15%, and to 5% for individuals in the lowest two income tax brackets.”
    That’s from Wikipedia – since when do rich people or anyone else for that matter not pay CGT?
    If you are sitting on an unrealised CapGain then you can’t spend that on consumption. Sooo, in order to consume that wealth you would sell realise a CapGain, and then pay tax. I mean what’s the confusion here?
    Warren Buffett is a gazillionaire but doesn’t sell his shares which would generate a huge cgt of course – also they don’t pay dividends, so his only consumption can come from his salary (and his private investments) – but no one is saying he’s not rich.

    • The accounting event that is designated as triggering a particular tax treatment is a separate (and important) issue.

    • Bongstar420

      Tax BracketCapital Gain Tax Rate
      Short Term Long Term
      10% 10% 0%
      15% 15%
      25% 25% 15%
      28% 28%
      33% 33%
      35% 35%
      39.6% 39.6% 20%

      Berkshire is down 2.5% for the last annual period
      My portfolio is up 140% for the same period

      You give Warren too much credit

  • Consistently non-violent

    Yes, unrealized gains are not captured by the national measurements or by tax authorities. On the other hand, neither is the opportunity costs associated with those gains which, if we want to be really economically complete, should also factor in.

    I can choose to work for wages, and save what I can, and take very little risk. If I take $30,000 of my savings, and invest it in a business, all of the income and profits on that business get recognized in our accounting, and gets taxed accordingly. What is missing–the bulk of the unrealized gains referenced by the author–are (a) what I could sell that business for today and (b) the opportunity cost of that $30,000 which, if that investment was made 20 or 30 years ago, is very significant, even with low inflation over most of that period. Those opportunity costs should account for the 50 percent plus chance that my businesses would have failed before making back my capital.

    I’m all for more complete accounting, including accounting for unrealized gains, in estimating how any entity or country is doing. I’m all for a more level playing field in our tax regime. But until our tax regime also accounts for the opportunity costs of the investments, I’m reasonably certain that any attempts to assess and tax those gains would almost certainly be economically counterproductive.

    • Bongstar420

      I think the point the author is trying to make is that rich people are still hiding income from the public. They in fact have access to more wealth then the accountants say

  • Pingback: Why Economists Ignore Much of Rich People’s Income – Evonomics | Investors Europe Interns()

  • Chuck Willer

    Thank you for bringing this issue to our attention.

  • Pingback: Why Economists Ignore Much of Rich People’s Income | thedailylearner()

  • Bongstar420

    So you can only make money on the stock market and be considered as having 0 income?

    Not saying these rich people would do that…its too much work for them

  • An eye-opening perspective. There are just so many aspects of how inequality is driven. Would invite to you my paper on one more perspective.

  • Commenters here might be interested in this latest, about how the U.S. national accounts basically ignored wealth until 2006, how the modern IMAs embrace it: