If People Were Paid by Ability, Inequality Would Plummet

By Jonathan Rothwell

Some may argue that top earners are simply super skilled, but that’s not what the evidence suggests.

Credit...James Best Jr./The New York Times

Income inequality in the United States would fall drastically if people were compensated based only on their ability.

The fundamental reason that income inequality is extraordinarily high in the United States relative to other democracies is the disparities in power across groups. Both the left and the right often miss how these disparities can play out.

The skills that really matter in the workplace are much more evenly distributed than many people assume. Most low-wage workers are underpaid relative to their measured intelligence and personality traits, and many of the highest-paid professionals — including doctors, lawyers and financial managers — are overpaid according to the same metrics.

Many people think that inequality is driven by irreversible trends in globalization and technological change, resulting in domination by multinational corporations and their executives.

Yet new academic research shows that most of the recent increase in income inequality has been driven by the owners of S corporations — which typically have one or two owners — and partnerships. These businesses are usually small regional operations focused on professional services (think law or medicine) or real estate. The most profitable pass-through businesses owned by millionaires are classified in legal services, in finance or as physician offices. These owners far outnumber executives of publicly traded companies among the nation’s top earners.

In fact, the rise of inequality over the last 40 years has coincided with the decline of income from conventional corporations (so-called C corporations) as a share of national income, from 59 percent in 1980 to 42 percent.

Data from the Census Bureau are consistent with this pattern. There are more doctors in the top 1 percent of earners (15 percent of the total) than chief executives (11 percent of the total). In fact, across nearly 500 occupational categories, doctors make up the largest group in the top 1 percent.

Lawyers and financial managers make up 7 percent and 3 percent of all top earners. Dentists are among the most likely to be in the top 1 percent; they actually outnumber software developers in that group.

Some may argue that top earners, whatever their occupation, are simply super skilled. But empirical evidence shows that skills cannot explain their pay.

The actual range of worker productivity is much narrower than the range of incomes. Research from management science finds that high-performing managers or professionals are roughly 50 percent more productive than a typical worker in the same role. That’s a large gap, but the salaries of many highly paid professionals — say those in the 85th percentile of their occupational group — are consistently at a far higher level than the median worker in the same field.

In some cases, elite professionals are able to earn more because of protection from market competition via state occupational licensing regulations. Associations representing lawyers, doctors and dentists can create costly obstacles to obtaining a license, research shows, and this blocks paralegals, nurse practitioners and dental hygienists from providing cheaper services.

Consider the measures that best predict economic performance. Cognitive ability, years of education, experience and noncognitive traits (like conscientiousness, enthusiasm and emotional stability) are all strong predictors of income and health status. Taken together, they make up much of what economists mean by human capital and consistently predict high performance in the workplace.

As part of research for my new book, “A Republic of Equals: A Manifesto for a Just Society,” I calculated what each individual’s income would be if she or he were paid according to the attributes listed above (using data from the Bureau of Labor Statistics’ National Longitudinal Survey). Comparing actual income inequality to predicted income inequality results in a reduction from 0.44 to 0.19 as measured by the Gini coefficient of inequality. Paying people based on their fundamental skills would make the United States as egalitarian as Sweden.

The reason? The distribution of skills is far more egalitarian than the distribution of income — and would be more equal still if access to high-quality education and skills training were more widely available.

Consider that the top 1 percent of earners in the United States score one-third of a standard deviation (or 5 IQ points) above the average adult on cognitive and workplace skills — measured from an assessment of adults by the Organization for Economic Cooperation and Development. Not bad, but not that unusual, either: Roughly 45 percent of adults score that high. To see this from another perspective, the average African-American adult with a graduate degree demonstrates the same level of cognitive ability in this international assessment as the average person in the top 1 percent of income. Yet 99 percent of African-Americans with graduate degrees do not have incomes high enough to be in the top 1 percent.

In the early 20th century, researchers have found, African-Americans were among the most inventive people in the world as measured by their likelihood of holding a patent. Racism, of course, blocked access to markets and other opportunities. For instance, black physicians were barred in many states from entering the American Medical Association until 1968, and the American Bar Association refused membership to black lawyers in any state until 1950.

When it comes to rising inequality, those on the left tend to cast blame on multinational corporations, and they see inherent flaws in markets. Those on the right tend to believe that inequality arises from differences in talent; they are more likely to say that market outcomes are intrinsically fair.

Both tend to miss how powerful interest groups (often local ones) can distort markets, creating rules to benefit their members at the public’s expense. Homeowner associations and the zoning boards that they elect routinely block legitimate market transactions in real estate, leading to higher housing prices and social segregation and isolation. (Townhomes, duplexes and apartments are essentially forbidden in many neighborhoods.) In many cases, state legislators have become dominated by regional lobbying associations, driving up the price of services. For both the left and the right, and everyone in between, it can be hard to see the true benefactors of rising income inequality: professional elites.

Beyond a commitment to equality, possible remedies include expanding access to high-quality public services like early-childhood education and community health services for needy families. But the evidence also suggests the need for expanding access to markets and defending their integrity. Both the right and left right would have to make compromises; it would seem to be a fair trade, with big gains for all.

Jonathan Rothwell is the author of “A Republic of Equals: A Manifesto for a Just Society,” which is published this week by Princeton University Press. He is the Principal Economist at Gallup, a nonresident senior fellow at the Brookings Institution and a visiting scholar at the George Washington University Institute of Public Policy. You can follow him on Twitter at @jtrothwell, and listen to his podcast, “Out of the Echo Chamber.”