When the topic of income inequality is raised there is often a perception that wealthy people spend their days playing golf or sunning themselves on yachts while others do all the work.
That’s not the case according to a newly published working paper co-authored by Princeton University.
The authors found that the ‘working rich’ - including lawyers, physicians, financial professionals, car dealers and beverage distributors – who run their own businesses, are prevalent within the top 0.1% of earners in the US (U$1.6m+ per year).
By analyzing around 11 million firms before the 2017 tax reforms, the authors discovered that most top income comes from pass-through (flow-through) companies where the profits and losses are passed through to owners themselves.
“We set out to understand what has been driving top incomes in recent years, and that upended some previous findings about the rich," said co-author Owen Zidar, assistant professor of economics at Princeton University's Woodrow Wilson School of Public and International Affairs. "It's common to wonder whether business owners grew the pie, or simply extracted more money from workers. It looks like both are important, but growing the pie may be more significant."
By looking at what happened to these pass-through businesses on the death or retirement of an owner, the study found that profits dropped by more than 80% and did not recover.
"We show that if you look and decompose this income, a lot of it comes from these pass-through businesses, and that activity more closely resembles labor than the idle rich," Zidar said. "Our results suggest that educating the country's next generation of innovators may be more important than tax incentives."
Zidar’s co-authors were Matthew Smith of the U.S. Department of the Treasury; Danny Yagan of the University of California, Berkeley; and Eric Zwick of the University of Chicago Booth School of Business. The working paper is currently under peer review by the Quarterly Journal of Economics.
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