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«SOEPpapers on Multidisciplinary Panel Data Research SOEP — The German Socio-Economic Panel Study at DIW Berlin 451-2012 Completing the Bathtub? The ...»

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451

SOEPpapers

on Multidisciplinary Panel Data Research

SOEP — The German Socio-Economic Panel Study at DIW Berlin 451-2012

Completing the Bathtub? The

Development of Top Incomes

in Germany, 1907-2007

Christina Anselmann and Hagen M. Krämer

SOEPpapers on Multidisciplinary Panel Data Research

at DIW Berlin

This series presents research findings based either directly on data from the German SocioEconomic Panel Study (SOEP) or using SOEP data as part of an internationally comparable data set (e.g. CNEF, ECHP, LIS, LWS, CHER/PACO). SOEP is a truly multidisciplinary household panel study covering a wide range of social and behavioral sciences: economics, sociology, psychology, survey methodology, econometrics and applied statistics, educational science, political science, public health, behavioral genetics, demography, geography, and sport science.

The decision to publish a submission in SOEPpapers is made by a board of editors chosen by the DIW Berlin to represent the wide range of disciplines covered by SOEP. There is no external referee process and papers are either accepted or rejected without revision. Papers appear in this series as works in progress and may also appear elsewhere. They often represent preliminary studies and are circulated to encourage discussion. Citation of such a paper should account for its provisional character. A revised version may be requested from the author directly.

Any opinions expressed in this series are those of the author(s) and not those of DIW Berlin.

Research disseminated by DIW Berlin may include views on public policy issues, but the institute itself takes no institutional policy positions.

The SOEPpapers are available at http://www.diw.de/soeppapers

Editors:

Jürgen Schupp (Sociology, Vice Dean DIW Graduate Center) Gert G. Wagner (Social Sciences) Conchita D’Ambrosio (Public Economics) Denis Gerstorf (Psychology, DIW Research Professor) Elke Holst (Gender Studies) Frauke Kreuter (Survey Methodology, DIW Research Professor) Martin Kroh (Political Science and Survey Methodology) Frieder R. Lang (Psychology, DIW Research Professor) Henning Lohmann (Sociology, DIW Research Professor) Jörg-Peter Schräpler (Survey Methodology, DIW Research Professor) Thomas Siedler (Empirical Economics) C. Katharina Spieß (Empirical Economics and Educational Science) ISSN: 1864-6689 (online) German Socio-Economic Panel Study (SOEP) DIW Berlin Mohrenstrasse 58 10117 Berlin, Germany Contact: Uta Rahmann | soeppapers@diw.de Completing the Bathtub?

The Development of Top Incomes in Germany, 1907-2007 Christina Anselmann* / Hagen M. Krämer* June 6, 2012 Abstract This paper examines the evolution of top incomes in Germany from 1907-2007 with a special focus on past decades. A more detailed analysis of German top incomes is conducted, beginning with a review of selected income distribution measures which indicate that high incomes have played a significant role for income divergence in recent years. Based on new data it is shown that top income shares have indeed increased substantially in the recent past, a process which is mainly due to a relative rise in employment rather than capital income within the top income groups. Finally, some theories explaining high incomes of the “working rich” are discussed.

Keywords: top income shares, income dispersion, executive compensation JEL Classification: D31, J30

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1 Introduction For several months, supporters of the Occupy Movement have been publicly criticizing the rising income and wealth disparity in the United States and various other countries around the world. Their main slogan, “We are the 99 percent!”, highlights the issue of the growing gap between rich and poor, explicitly the income and wealth concentration among the top one percent of the population compared to the bottom 99 percent. Shortly after the initiation of the protest movement, the US Congressional Budget Office published a report in fall 2011 stating that real after-tax income grew by 275 percent for the top one percent of all US households in the period from 1979 to 2007 whereas after-tax income for all other income fractiles only increased by a maximum of 65 percent. Eventually, solely the upper quintile – and within mainly the top one percent – could increase its share of after-tax income while all other income groups saw a decline in their income shares (cf. Congressional Budget Office 2011).

During the past years, several studies revealed that the evolution of high incomes has had a significant impact on overall income inequality. For instance, Alvaredo (2010, pp.5) mentions that in the United States the Gini coefficient for the bottom 99 percent of the population only increased by 3.2 percentage points, whereas the Gini coefficient including the top one percent rose by 8.8 percentage points between 1976 and

2006. Looking at the long-term development in the US from 1917 to 2007, Figure 1 gives a broader picture of overall trends. Until the late 1920s the income share of the top ten percent of the distribution climbed to a rather high level of some 46 percent, and subsequently declined moderately during the Great Depression. It then, however, decreased substantially during World War II and afterwards remained relatively constant for a long period between 1945 and 1980. Starting in the early 1980s the share of the top ten percent experienced a remarkable recovery and in 2007 restored to its level of

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Source (Figures 1 and 2): Alvaredo et al. 2012, Tables United States and Germany. The developments which mainly dominated the general pattern of top income shares over the twentieth century are highlighted in color: The years of the Great Depression are shaded in blue, the years of the Great Compression are shaded in green, and the years of the Great Divergence are shaded in red.

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this phrase to describe the sharp downturn of top income shares during World War II and its constancy in subsequent decades. In light of the significant rise in income differences, the period since 1980 can, in contrast, be called the Great Divergence (Krugman 2007). To sum up, when looking at Figure 1 one can imagine the development of the top decile share in US gross income to exhibit a U- or “bathtub”-shape over the eighty years between 1927 and 2007.

According to Atkinson and Piketty, the strong growth in top income shares has been occurring in several English-speaking countries during the last decades, whereas in Continental Europe “[…] there has not been a U-shaped pattern over the twentieth century.” (Atkinson/Piketty 2007b, p. 541) The present paper is mainly concerned with the developments in Germany and challenges the view that the recovery of top incomes cannot be found there. Figure 2 illustrates that the top decile income share in Germany decreased substantially in the years of hyperinflation2 after the First World War but, other than in the United States, increased during the Great Depression.3 Another rise in top income shares after the Nazis came to power was then followed by a sharp downturn subsequent to the Second World War.4 Similar to the US-development, we find a Great Compression period in Germany, yet it ended later: From 1961 until the beginning of the 1990s the share of the top ten percent oscillated on a rather low and constant Further information on the development of top income shares during the years of hyperinflation is provided by Dell 2007, pp. 372.

As can be seen from a comparison between Figures 1 and 2, the blue shaded areas indicating the Great Depression are not covering the same years in the United States and in Germany. Following Dell (2007), in Germany the years from 1933 (seizure of power by the Nazis) until the outbreak of the Second World War are considered separately (cf. Dell 2007, pp. 373), whereas such a differentiation is not necessary for the United States.

During the Great Depression, the evolution of the German top decile income share was exceptionally dominated by the developments of lower income fractiles within the top ten percent of the distribution. While the income ratios of the highest income groups (top one percent, top 0.01 percent) decreased only slightly between 1929 and 1933, the lower income fractiles (top 10-5 percent, top 5-1 percent) experienced a sharp rise in their income shares. “On the one hand, the higher part of the top decile did not significantly suffer of the Depression and of the deflationary measures imposed by the […] government at the time, and on the other hand, the lower part of the top decile, being mainly composed of (short-term downward rigid) wages […], deflation did not hit them and even made their relative weight grow.“ (Dell 2007, pp. 373). However, after the seizure of power by the Nazis in 1933, this development reversed and the top groups regained income share, whereas the ratios of lower income groups within the top ten percent declined.

It should be noted, however, that the series from 1937 until 1960 is incomplete (see Figure 2).

-4level between 30 and 33 percent. The stability of this share, which unlike in the US can still be found in the 1980s and early 1990s, seems to support the “stylized fact” of rigid unchanging wage structures in the German labor market (cf. Atkinson 2008, p. 3). Although there appears to be a slight upward trend since the late 1980s, it is obvious that the evolution of top income shares in Germany did not finish a complete bathtub-shaped pattern in the twentieth century. In contrast to the data for the United States which clearly indicate a Great Divergence, the series for Germany is not applicable to confirm a similar evolution. However, Atkinson and Piketty are analyzing data which end in 1998, so the question arises whether the modest increase that emerged in the late 1980s has continued during the past years. Has the “bathtub” been completed in Germany in the recent past, or is it still valid to refer to a non-U-shaped pattern of German high income shares?

The second question addressed in the present paper concerns the composition of high incomes. Intuitively, one would assume that incomes at the top of the distribution are mainly composed of capital income, while wages and salaries play only a minor role. Thus, it is quite surprising that prior to World War II incomes of the top groups in the US were predominantly composed of capital income, whereas the recent rise in high income shares is primarily due to an increase in employment income (cf. OECD 2011a, pp. 347). Can similar patterns be found in German top incomes as well?

To shed more light on this, the present paper examines the evolution of top incomes over the past decades in more detail. The next section starts with a review of some appropriate income measures which demonstrate that in Germany top incomes have also increased significantly during the past years. Based on new data from The World Top Incomes Database by Alvaredo/Atkinson/Piketty/Saez (2012) as well as recent figures by Bach/Corneo/Steiner (2009, 2011), a more detailed analysis of Ger

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growing impact of labor income within top incomes and stresses the importance of the “working rich”. Part 4 discusses some underlying theories about top incomes. Section 5 finally summarizes the main results and draws some conclusions.

2 Some general trends in personal income distribution in Germany According to recent OECD studies, Germany is one of the countries in which overall income dispersion increased most significantly over the past decades. Between 1985 and 2008, the Gini coefficient rose from 0.251 to 0.295 and thus grew by more than four percentage points.5 Although the German Gini index is still slightly below the OECDaverage (0.316), higher growth rates were recorded only in Sweden, New Zealand, Finland, and Israel (cf. OECD 2011a, pp. 22; OECD 2012a, pp. 80). Time-wise, it is striking that income differences first started to increase in some English-speaking nations at the beginning of the 1980s, whereas this development set in only about a decade later in other countries. In Germany, the growth of the Gini index was almost twice as large between the mid-1990s and 2008 as in the first sub-period from 1985 to the mid-1990s (cf. OECD 2012a, pp. 80). This development seems to be in line with the evolution of top income shares illustrated in Figures 1 and 2: While the income share of the top decile in the US started to rise again at the beginning of the 1980s, the upward trend in Germany did not set in until the late 1980s and the beginning of the 1990s. However, the Gini coefficient is especially sensitive to changes in the middle of the distribution, so its intense increase during the past years does not necessarily imply that top income shares have also grown and thereby the “bathtub” pattern of top incomes has been completed in Germany. While the OECD reports that “inequality has generally […] [arisen] because rich households have done particularly well in comparison with middle-class The Gini coefficient refers to real equivalent annual net household income (modified OECD equivalence scale). An overview of data sources and income concepts used in the present paper is listed in Appendix A.1.

-6families and those at the bottom of the income distribution” (OECD 2008, p. 17), this statement still has to be confirmed for Germany by taking a closer look at some other measures which are more appropriate to indicate changes in the upper part of the distribution. Based on data from the German Socio-Ecnomic Panel Study (SOEP), a longitudinal study of private households in Germany, chosen income components and indicators are analyzed in the following.6

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Source: German Socio-Economic Panel Study 2010, pp. 81. Series deflated by consumer price index (base year 2005).

A comparison between the developments of mean and median income reveals that the benefits of economic growth were spread unevenly across the German population during the past years. As illustrated by Figure 3, both income parameters increased from 1984 to 2010, but they grew to varying degrees. While average income rose by 4,745 Euro, or 29.7 percent, median income grew by only 3,567 Euro, or 24.5 percent.

The gap between mean and median income started to increase at the beginning of the

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