Chance favors the concentration of wealth, U of M study shows

University of Minnesota
July 21, 2011
Jeff Falk

Most of our society's wealth is invested in businesses or other ventures that may or may not pan out. Thus, chance plays a role in where the wealth of a society will end up.

But does chance favor the concentration of wealth in the hands of a few, or does it tend to level the playing field? Three University of Minnesota researchers have built a simplified model that isolates the effects of chance and found that it consistently pushes wealth into the hands of a few, ever-richer people.

The study, "Entrepreneurs, chance, and the deterministic concentration of wealth," is published in the July 20 issue of the journal PLoS ONE.

The researchers simulated the performance of a large number of investors who started out with equal amounts of capital and who realized returns annually over a number of years. But wealth did not remain equal, because each year an entrepreneur's return was a random draw taken from a pool of possible return rates. Thus, a high return did not guarantee continuing high returns, nor did early low returns mean continuing bad luck.

Even though all investors had an equal chance of success, the simulations consistently resulted in dramatic concentration of wealth over time. The reason: With compounding capital returns, some individuals will have a string of high returns and, given enough time, will accumulate an overwhelming share of the wealth.

This appears to be a fundamental feature of economies where wealth is primarily generated from returns on investment (for example, through business ownership and growth), the researchers said.

"Predictions from this model about how wealth is distributed were more accurate than predictions from classic economic models," said first author Joseph Fargione, an adjunct professor of ecology, evolution and behavior in the university's College of Biological Sciences.

The model predicts that the rate at which wealth concentrates depends on the variation among individual return rates. For example, when variation is high, it would take only 100 years for the top 1 percent to increase their share of total wealth from 40 percent—a recent level in the United States—to 90 percent.

Healthy economies support diverse entrepreneurial efforts, leading to high economic growth. But concentration of wealth reduces diversity, and with it the most likely growth rate for a country's economy, according to the researchers.

"The implication is that nations with diverse economies should tend to outcompete on the world stage those with large concentrations of wealth, such as monarchies, or established democracies that have allowed their wealth to concentrate," said author Clarence Lehman, associate dean for research in the College of Biological Sciences.

But while the rate of wealth concentration was increased by high variation among individual investors' returns, it bore no relation to the average economic growth.

"This leads to the surprising finding that wealth will concentrate due to chance alone in growing, stagnant or shrinking economies," said author Steve Polasky, professor of applied economics in the College of Food, Agricultural and Natural Resource Sciences.

The simulation results showed wealth concentrating regardless of economic cycles of growth and recession and regardless of whether wealth is split between two offspring every generation. As wealth concentrates with a few individuals, the growth of the economy will depend more and more on the returns of those few, making the economy less resilient to disruptions in their investments, the researchers said.

"The irony is that the economic diversity that helps ensure the presence of some successful enterprises and spurs economic growth could be lost if the success of these enterprises undermines economic diversity," said Fargione. "To retain the benefits of a diverse capitalist economy, we need economic policies that counter what seems to be the innate tendency for economies to concentrate wealth and become less diverse." 

The simulations showed that a tax (or other mandatory donation to the public good) on the largest inherited fortunes would short-circuit the over-concentration of wealth. But the researchers stress that their point is to advocate not a particular policy, but a policy that accomplishes the goal of protecting long-term economic stability.

United States of America is awash in wealth...BUT...(Institute for Policy Studies)

Reversing tax giveaways to the super-rich

and the nation's largest corporations

could raise $4 trillion within a decade

and avert possible government closures.

Institute for Policy Studies
By: Chuck Collins, Alison Goldberg
Scott Klinger and Sam Pizzigati
April 7, 2011


"We're broke."

Or so claim governors and lawmakers all over the country. Our states and our nation can no longer afford, their plaint goes, the programs and services that Americans expect government to provide. We must do with less. We need "austerity."

But we're not broke. Not even close. The United States of America is awash in wealth. Our corporations are holding record trillions in cash. And overall individual wealth in the United States, the Credit Suisse Research Institute reported this past fall, has risen 23 percent since the year 2000, to $236,213 per American adult.

We have, these indicators of overall wealth suggest, survived the Great Recession quite nicely. So how can average families — and the national, state, and local governments that exist to serve them — be doing so poorly? Why do "deficits" dominate our political discourse? What explains the red-ink hurricane now pounding government budgets at every level?

This Tax Day report identifies two prime drivers behind our current budget "squeeze."

One, we have indeed become wealthier than ever. But our wealth has become incredibly more concentrated at our economic summit. U.S. income is cascading disproportionately to the top.

Two, we are taxing the dollars that go to our ever-richer rich — and the corporations they own — at levels far below the tax rates that America levied just a few decades ago. We have, in effect, shifted our tax burden off the shoulders of those most able to bear it and away from those who disproportionately benefit from government investments the most.

These two factors — more dollars at the top, significantly lower taxes on these dollars — have unleashed a fiscal nightmare. Can we wake up in time to avoid the crippling austerity that so many of our political leaders insist we must accept?

This report offers both an analysis of our current predicament and a series of proposals that can help open our eyes to a far more equitable — and brighter — future.

Key Tax Facts

• 15,753: The number of households in 1961 with $1 million in taxable income (adjusted for inflation).
• 361,000: The number of households in 2011 estimated to have $1 million in taxable income.
• 43.1: Percent of total reported income that Americans earning $1 million paid in taxes in 1961 (adjusted for 2011 dollars)
• 23.1: Percent of total reported income that Americans earning $1 million are likely to pay in taxes in 2011, estimated from latest IRS data.
• 47.4: Percent of profits corporations paid in taxes in 1961.
• 11.1: Percent of profits corporations paid in taxes in 2011.

Chuck Collins: If corporations and households with $1 million income paid the same levels as they did in 1961, the Treasury would collect an additional $716 billion a year.

Welcome to the Banana Republic: The richest 1 percent of Americans now take home almost 24 percent of income, up from almost 9 percent in 1976

C.E.O.’s of the largest American companies

earned an average of 42 times as much

as the average worker in 1980,

but 531 times as much in 2001.

By Nicholas D. Kristof
The New York Times
11/6/10

In my reporting, I regularly travel to banana republics notorious for their inequality. In some of these plutocracies, the richest 1 percent of the population gobbles up 20 percent of the national pie.

But guess what? You no longer need to travel to distant and dangerous countries to observe such rapacious inequality. We now have it right here at home — and in the aftermath of Tuesday’s election, it may get worse.

The richest 1 percent of Americans now take home almost 24 percent of income, up from almost 9 percent in 1976. As Timothy Noah of Slate noted in an excellent series on inequality, the United States now arguably has a more unequal distribution of wealth than traditional banana republics like Nicaragua, Venezuela and Guyana.

C.E.O.’s of the largest American companies earned an average of 42 times as much as the average worker in 1980, but 531 times as much in 2001. Perhaps the most astounding statistic is this: From 1980 to 2005, more than four-fifths of the total increase in American incomes went to the richest 1 percent.

That’s the backdrop for one of the first big postelection fights in Washington — how far to extend the Bush tax cuts to the most affluent 2 percent of Americans. Both parties agree on extending tax cuts on the first $250,000 of incomes, even for billionaires. Republicans would also cut taxes above that.

The richest 0.1 percent of taxpayers would get a tax cut of $61,000 from President Obama. They would get $370,000 from Republicans, according to the nonpartisan Tax Policy Center. And that provides only a modest economic stimulus, because the rich are less likely to spend their tax savings.

At a time of 9.6 percent unemployment, wouldn’t it make more sense to finance a jobs program? For example, the money could be used to avoid laying off teachers and undermining American schools.

Likewise, an obvious priority in the worst economic downturn in 70 years should be to extend unemployment insurance benefits, some of which will be curtailed soon unless Congress renews them. Or there’s the Trade Adjustment Assistance program, which helps train and support workers who have lost their jobs because of foreign trade. It will no longer apply to service workers after Jan. 1, unless Congress intervenes.

So we face a choice. Is our economic priority the jobless, or is it zillionaires? Banana Republic Continued

Nicholas Kristof Blog