Marin Community Foundation
Wealth Inequality, Explained
Research

Review: How the Richest Got That Way

Originally published by Gregory Clark, Wall St Journal [link] on December 11, 2017

Like Thomas Piketty’s “Capital in the Twenty-First Century,” the book that it will inevitably be compared with, Edward Wolff’s “A Century of Wealth in America” is a massive tome. Its dense 865 pages come replete with statistical tests, tables and equations describing the patterns and history of wealth-holding in the United States. Very little thought, however, has been given to making the presentation interesting and engaging for the lay reader. This is a work for specialists. Yet Mr. Wolff’s magnum opus is also a highly timely book, for it contains a trove of interesting material that is highly germane to a political moment when the issue of wealth inequality is on everyone’s lips.

Drawing heavily for recent years on the Federal Reserve Board-sponsored Survey of Consumer Finances, Mr. Wolff finds evidence of a long-run growth in wealth inequality in the United States from 1946 on—though a much more muted rise than other researchers, such as Mr. Piketty, have claimed. His evidence suggests that the United States now has the greatest wealth inequality among developed economies and that the recovery from the recession of 2008 is manifesting itself, in part, in a renewed growth in the wealth of the richest.

Despite the liberal background of the author, however, “A Century of Wealth in America” offers comfort and support to those who favor less wealth taxation. A core element of Mr. Piketty’s indictment of contemporary wealth inequality was his claim that inheritance is the major source of wealth; he estimated that, given the slower economic growth that most economists anticipate in the future, inherited wealth would soon constitute 90% of wealth in economies such as that of the United States. But Mr. Wolff finds that, for modern America, wealth inheritance explains a much more modest share of private wealth: In 1989-2013, it was 23% on average. In other words, more than three-quarters of all wealth is created anew in each generation in the U.S. From what activities that new wealth comes, however, Mr. Wolff’s sources do not reveal. The book is no guide to getting rich in modern America.

Even more surprising, inherited wealth is much more important in the lives of those who have relatively little wealth than it is in the lives of the super rich. For the top 1% of wealth holders from 1989 to 2013, inherited wealth accounted for only 17% of their assets. (The 1%, in this analysis, is an overwhelmingly self-made group.) By contrast, for those with assets of just $25,000-$50,000, inherited wealth accounted for 52% of their worth.

As a bizarre consequence of this pattern, African-Americans, who have low levels of net worth on average, are the social group for which inherited wealth represents the largest share of their net worth. Another odd implication is that inheritances tend to make overall wealth-holding more equal. Were inherited wealth to be completely abolished, the wealth of the poor would decline more than that of the rich. Inherited wealth is the great equalizer. Who knew?

Why is inheritance so unimportant as a source of wealth among the rich? Is it that children and other inheritors tend to dissipate their inheritances quickly, so that newly created wealth dominates in each generation? Or do the super wealthy in the U.S. tend to bequeath much of their wealth not to their children or collateral relatives but to charitable foundations? Unfortunately, Mr. Wolff’s sources are mute on these questions as well.

Another intriguing correlation that Mr. Wolff’s sources illuminate but do not explain is that between health and wealth. While the top 1% of wealth holders are, on average, 20 years older than the typical person in the Survey of Consumer Finances, they report themselves to be in much better health than the average respondent. In 2013, for example, 45% reported “excellent” health, and only 1% reported “poor” health, compared with 24% and 6% for the population as a whole. What is going on here? Does health make wealth, or vice versa?

Finally, Mr. Wolff calculates that the rich are not systematically generating higher returns on their assets than more modest wealth holders. The top 1% had a real return on net worth of around 3% over the 30 years from 1983 to 2013—the same return as the average wealth holder. Though the contents of typical asset portfolios varied by wealth, the less-well-off individuals with more of their investments in housing were actually more highly leveraged than richer ones. In these years, borrowing to invest turned out be mostly a good idea, helping them generate average real net returns as great as those for the richest. (In this calculation, Mr. Wolff has to assume that the rich don’t have ways to generate higher returns on equity than typical investors, or that any extra returns generated by hedge funds and other investment vehicles that only the rich have access to are consumed in management fees.)

The final chapter of “A Century of Wealth in America” turns to tax policy. The corporate tax cut currently making its way through Congress will benefit primarily the wealthy, since they are the main holders of corporate stock, and Mr. Wolff’s book illustrates well what a strange political moment it is for Congress to be writing laws in favor of the wealthy. But what would its author propose instead? Here the rich can rest easy. Mr. Wolff argues for a Swiss-style levy on wealth—i.e., assets, not income—that would average around 0.19% a year, but only for assets above a generous threshold. And yet the rather drastic measures the author proposes, he admits, would “make barely a dent in overall wealth inequality,” reducing the annual investment yield on wealth by about 6%.

“A Century of Wealth in America” could equally well serve as a rallying document for supporters of the current tax bill as for those favoring wealth taxation. An America where the great bulk of wealth springs fresh from enterprise in each generation, and where meritless inheritance is only a minor source of riches, is one that is politically congenial for those who propose incentivizing further wealth creation.