The Distribution of Income; H. Hazlitt

Let us consider these charges. That the capitalist system could ever have been accused of being unproductive, or of being very in efficiently productive, will seem incredible to most economic stu dents of the present day, familiar Henry Hazlitt is well known to FREEMAN readers as author, columnist, editor, lecturer, and practitioner of freedom. This article will appear as a chapter in a forthcoming book, The Conquest of Poverty, to be published by Arlington· House. with the record of the last gen eration. It will seem even more incredible to those familiar with the record since the middle of the eighteenth century. Yet the im provement in that early period remained hidden even from some astute contemporary observers. Thomas Malthus in 1798 (the date of the first edition of his Essay on Popula,tion) seemed hardly aware of the productive transformation already achieved in the first half of the Industrial Revolution.!

Yet much earlier, in 1776, Adam Smith had shown keen awareness of improvement: "The uniform, constant, and uninterrupted effort of every man to better his condi tion . . . is frequently powerful enough to maintain the natural progress of things toward im1 See "The Problem of Poverty" in THE FREEMAN, June, 1971. pp. 325-6. 605 606 THE FREEMAN October provement, in spite of the extrav agance of government, and of the greatest errors of administra tion."2 Smith rightly attributed this progress to the steady increase of capital brought about by private saving - to the "addition and im provement to those machines and instruments which facilitate and abridge labor." "To form a right judgment" of this progress, he continued, "one must compare the state of the country at periods somewhat dis tant from one another. [So as not to be deceived by short periods of recession.] ... The annual prod uce of the land and labor of Eng land, for example, is certainly much greater than it was a little more than a century ago at the restoration of Charles 11." And this again was certainly much greater "than we can suppose it to have been about a hundred years before, at the accession of Elizabeth." Quite early in The Wealth of Nations we find Smith referring to the conditions of his own period as being compara tively, as a result of the increas ing division of labor, a period of "universal opulence which extends itself to the lowest ranks of the people."3 2 The Wealth of Nations, Book II, Ch.

III. 3 Book I, Ch. 1. If we leap ahead another cen tury, we find the economist Alfred Marshall writing in the 1890's: "The hope that poverty and ig norance may gradually be extin guished, derives indeed much sup port from the steady progress of the working classes during the nineteenth century. The steam engine has relieved them of much exhausting and degrading toil ; wages have risen; education has been improved and become more general. ... A great part of the artisans have ceased to belong to the 'lower classes' in the sense in which the term was originally used; and some of them lead a more refined and noble life than did the majority of the upper classes even a century ago."4 Statistical Comparisons For more recent years we have the great advantage of getting be yond more or less impressionistic comparisons of economic progress to fairly reliable statistical com parisons. Our chief care here must be to avoid making such compari sons in terms of dollar income at current prices. Because of the con tinuous monetary inflation in the United States since the 1930's, this would give a very misleading impression. To get a true picture of the real improvement in pro4 Principles of Economics, Eighth edi tion, pp. 3-4.

1971 THE DISTRIBUTION OF INCOME 607 Source: Department of Commerce. 5 Based on estimates by the Depart ment of Commerce expressed in "con stant" (1958) dollars. In the ten years from 1939 to 1949, then, the real gross national product of the country increased 55 per cent; in the twenty years from ·1939 to 1959 it increased 127 duction and welfare, in so far as these are measurable, allowance must be made for price increases. Statisticians do this by deflating recent prices and incomes in ac cordance with index numbers of average prices - in other words, by making their comparisons in terms of so-called "constant" dol lars. Let us begin with some over-all figures. In the 59 years between 1910 and 1969 it is estimated that the real gross national product of the United States (the GNP) in creased at an average rate of 3.1 per cent a year compounded. 5 At such a rate the production of the country has been more than doub ling every 24 years.

Let us see how this has looked expressed in billions of 1958 dol lars: Which Groups Gain Most? The foregoing figures do noth ing, it is true, to answer the charge that capitalism distributes Source: Department of Commerce. Year Per capita income 1929 $1,236 1939 1,190 1949 1,547 1959 1,881 1969 2,517 In other words, disposable per capita personal income at con stant prices increased 112 per cent - or more than doubled - in the generation from 1939 to 1969. This disposes effectively of the charge that capitalism is unpro ductive, or unacceptably slow in increasing production. In the thirty years from 1939 to 1969 the United States was still the most capitalistic country in the world; and the world had never before witnessed anything comparable with this vast production of the necessities and· amenities of life. per cent; in the thirty years from 1939 to 1969 it increased 242 per cent.

If we now express this in terms of disposable per capita personal income (at 1958 prices) for these same years, the comparison is less striking because we are allowing for the growth in population, but the progress is still remarkable: GNP $203.6 209.4 324.1 475.9 727.1 Year 1929 1939 1949 1959 1969 608 THE FREEMAN October Source: Department of Labor. So, far from wages failing to keep pace with increases in living costs, real wages rose lOS per cent in this thirty-year period. Was the worker getting his "fair share," however, in the gen eral increase in production - or was he getting a smaller share compared with, say, the owners of industry? Dividing the Pie Let us begin by looking at the sources of personal income. Of the nation's total personal income of $801 billion in 1970, $570.5 billion, or 71 per cent, was in wages and salaries and other labor income. Income from farming came to $16.2 billion, or 2 per cent; busi ness and professional income was $51.4 billion, or 6.4 per cent.

Rental income received by persons was $22.7. billion, or 2:S per cent; dividends came to $25.2 billion, or 3.1 per cent; interest received by persons was $65.2· billion, or 8.1 per cent. (Source: Economic In dictators, June, 1971,Council of Economic Advisers.) If. we total these last three items we get its gains unjustly - that it bene fits only the already rich, and leaves the poor, at best, no better off than they were before. These charges are at least partly an swered, however, as soon as we compare the median incomes of families in constant (1969) prices: Families Median Year (millions) Income 1949 39.3 $4,779 1959 45.1 6,808 1969 51.2 9,433 Source: Department of Commerce. As the median income means that there were just as many families earning .more than the amount cited as those earning less, it follows that the 97 per cent increase of median real incomes in this twenty-year period must have been shared in by the mass of the people.

Other sets of figures confirm this conclusion. If we compare weekly wages paid in manufactur ing, we find that these rose from $23.64 in 1939 to $129.51 in 1969 - an increase of 448 per cent. As the cost of living was constantly' rising during this period, this of course greatly exaggerates labor's gains. Yet even after we restate these wages in terms of constant (1967) prices, we find the follow ing changes in average gross weekly earnings: Year 1939 1949 1959 1969 Wages (in 1967 prices) $56.83 75.46 101.10 117.95 1971 THE DISTRIBUTION OF INCOME 609 $113.1 billion, or 14.1 per cent, of "unearned" income. (The income from farming and from. business was partly "earned" and partly "unearned," in undeterminable proportions. ) It is doubtful how much all this tells us about the distribution of income between the "rich" and the "poor." Total wage and salary dis bursements include the salaries of high-paid executives and of tele vision and motion-pic~ure stars.

On the other hand, reltals, divi dends, and interest pa;ments in clude many millions ofj moderate sized individual sums 1that may represent the major phrt or the sole means of support of widows and orphans and persons too old or too ill to work. (There are some 30 million American stockholders, for example, and 25 million sav ings-bank accounts.) A very significant figure, how ever, is the comparison of how much the employees get from the corporations with how much the owners get. Let us look first at a few facts about profits. In the five year period 1965 to 1969 inclusive, all manufacturing corporations of the United States· earned profits after Federal income taxes of only 5.2 cents per dollar of sales. Manu facturing corporation profits af ter taxes as a percentage of stock holders' equity look a little better - they averaged 12.3 per cent for the same five years. (Source: Eco nomic Report of the President, February, 1971, p. 284.) Both of these figures, however, overstate the real profits of the corporations. In a period of con tinuous inflation like the present, the corporations are forced by the tax laws to make inadequate de ductions for depreciation of plant and equipment, based on original cost, and not sufficient to cover re placement costs. Profits as a per centage of equity are overstated for still another reason: they are stated in dollars of depreciated purchasing power compared with the dollars that were originally in vested.

Lion's Share to Employees What is more significant (and constantly forgotten) is that the employees of the corporations draw far more from them than the owners. This is exactly the op posite of what is commonly be lieved. Surveys by the Opinion Re search Corporation have found that the median opinion of those polled was that the employees of American corporations receive only 25 cents out of each dollar available for division between the employees and the owners, and that the remaining 75 cents goes to profits. The facts are quite the opposite. In 1970, for example, of the U. S. corporation income avail610 THE FREEMAN October Year 1970 1969 1968 1967 1966 1960 1955 able for distribution between the workers and the owners, nine tenths went to the workers and only one-tenth to the owners. Here is how, in billions of dollars, the division appeared over a series of years: DIVISION OF U.S. CORPOR.ATE INCOME BETWEEN EMPLOYEES AND STOCKHOLDERS Profits % for AfterTax Payrolls Payroll $36.4 $366.0 91.0 40.0 350.5 89.8 44.2 319.2 87.8 43.0 291.8 87.2 46.7 275.5 85.5 24.8 188.8 88.4 25.4 144.6 85.1 Derived from Office of Business Economics, U.S. Department of Commerce.

If we average out the five years from 1966 to 1970, we find that compensation to employees came to 88.2 per cent of the corporation income available for division, and only 11.8 per cent, or less than an eighth, went to profits available for share owners. So if American workers are be ing "exploited" by the capitalists, it is certainly not evident from the figures. One important fact that the anticapitalist mentality so often forgets is that corporation earnings do not constitute a com mon pool. If manufacturing corpo rations earn an average of 12 per cent on their equity, it does not mean that every corporation earns this average profit margin. Some will earn 20 per cent on equity, some 10 per cent, some 3 per cent - and many will suffer losses. (Over a 40-year period an average of 45 per cent of companies - by number - reported losses annually. As a general rule, small companies suffered losses more frequently than did the large corporations.) Another point to be kept in mind: When profits are large, it does not mean that they are at the expense of the workers. The op posi te· is more likely to be true.

In 1932 and 1933, for example, the t,vo years when the nation's cor porations as a whole showed a net loss, the workers also suffered their worst years from unemploy ment and wage cuts. In a competi tive capitalistic economy, aggre gate profits and aggregate wages tend to go up or down together. It is to the long-run interest of the workers as well as of stock holders for profits to be high. A Look at Family Incomes Turning from the sources of in come, we come now to increases in family incomes over recent years and to the division of in come as between various segments of the population. Because of ris ing prices, comparisons between different years of family incomes in current dollars have little mean ing. Here is a comparison, how1971 THE DISTRIBUTION OF INCOME 611 Source: U. S. Department of Commerce, Bureau of the Census. Source: U. S. Department of Commerce, Bureau of the Census.

ever, of the per cent distribution of white families by income level, in constant (1968) dollars, be tween 1950 and 1968: The sharp drop in the percent age of families with "constant" in comes under $3,000 is especially noteworthy. The rise in the over all "real" median income in this eighteen-year period was 79 per cent. The per cent of aggregate in come received by each fifth. of the number of families in the country, and the per cent of aggregate in come received by the top 5 per cent of families, has changed much less over the years, but such change as has occurred has been toward a more equal distribution: % of Income Received 5.7 12.4 17.7 23.7 40.6 14.0 5.0 Income Range Under $4,600 $4,600-$7,400 $7,400-$10,000 $10,000-$13,500 $13,500and over $23,000and over $42,500and over Derived from Herman P. Miller, Rich Man, Poor Man (Crowell, 1971.) p. 15. How Government Intervention Affects Each Group A study published on March 18, 1971 by two Census Bureau stat isticians, Herman P. Miller, di rector of the Census Bureau's population studies, and Roger A.

Herriot, concluded that the proc esses of government now shift in come from rich to poor with sub stantially greater effect than is commonly believed. They contended that most families pay direct and indirect taxes at about the same rate - 30 per cent - regardless of income level; but that when pay ments from government (such as unemployment insurance) are taken into account, the result is a Families Lowest fifth Second fifth Middle fifth Fourth fifth Highestfifth Top 5 per cent Top 1 per cent If the reader wishes to know how the various fifths of the popu lation ranged in actual incomes in 1968, and in which fifth or bracket his own family income fell, he can learn it from the fol lowing table: 1968 5.7% 12.4 17.7 23.7 40.6 14.0 1968 8.9% 11.0 14.3 24.0 26.1 15.7 $8,936 1960 4.9% 12.0 17.6 23.6 42.0 16.8 1950 23.4% 26.8 22.9 16.6 10.2 I $4,985 1947 5.0% 11.8 17.0 23.1 43.0 17.2 Families Lowest fifth Second fifth Middle fifth Fourth fifth Highestfifth Top 5 per cent Family Income Under $3,000 $3,000-$4,999 $5,000-$6,999 $7,000-$9,999 $10,000-$14,999 $15,000 and over Median income 612 THE FREEMAN October markedly progressive redistribu tion of income. For example, fam ilies with earned income of less than $2,000 a year in 1968, ac cording to the study, paid an esti mated 50 per cent of their income for all taxes - but got back 106.5 per cent in government payments.

So their "net" tax was not a tax at all, but a, benefit of 57 per cent. Families with over $50,000 a year, meanwhile, paid 45 per cent in to tal· taxes and got back less than 1 per cent. So their net tax was 44.7 per cent of income. 6 The income comparisons here presented fail to give any support whatever to the socialist conten tion that under a capitalist system the tendency is for the rich to get richer and for the poor to get poorer - or at any· rate for the proportional "gap" between the rich and poor to increase. What the figures show, on the contrary, is that in a healthy, expanding capitalist economy the tendency is for both the rich and the poor to get richer more or less propor tionately. If anything, the posi tion· of .the poor tends to improve better than proportionately. This becomes even clearer if, instead of merely comparing in6 The estimate that families with earned incomes of less than $2,000 a year paid a total in taxes of 50 per cent of their income seems on its face extremely high, but I cite the conclusions of the study as given.

comes in terms of dollars, we look at the comparative gains of the poor that have been brought about by the technological· progress that has in turn to so large an extent been brought about by capitalism and capital accumulation. As Herman P. Miller has pointed out: "Looking back, there is good reason to wonder why the 1920's were ever regarded as a golden age .... Take for· example a sim ple matter like electric power. To day electricity in the home is taken for granted as a more or less inalienable right of every Amer ican. Practically every home - on the farm as well as in the city is electrified. Even on southern farms, ninety-eight out of every hundred homes have electricity. In 1930, nine out of every ten farm homes were without this 'neces sity.' And the country was much more rural than it is now. "A more striking example is provided by the presence of a toilet in the home. . . . As recently as 1940, about 10 per cent of city homes and 90 per cent of farms lacked toilet facilities within the structure. This is not Russia or China that is being described, but these United States only thirty years ago."7 Even the skeptical Paul Sam uelson conceded in 1961 that "the 7 Rich Man, Poor Man (New York: Thomas Y.Crowell Co., 1971), pp. 44-45.

1971 THE DISTRIBUTION OF INCOME 613 Source: U. S. Department of Commerce, Bureau of the Census. American income pyramid is be coming less unequal."s 8 Economics: An Introductory Analy sis, 5th edition (New York: McGraw Hill Book Co.), P. 114. In view of the fact that govern ment statisticians officially placed the "poverty threshold" for 1969 at $3,721 fora family of four, and $4,386 for a family of five, the percentage of families with in comes less than this who own cars and appliances is remarkable. In 1969, in addition, 90 per cent of all American households had tele phone service. To these figures on the distri bution of physical appliances we must add many intangibles. The most important of these is the enormous increase in the number of those who have enjoyed the ad vantage of an education. Broadly speaking, the percentage increase has been greatest for those at the bottom of the pyramid. A century ago (1870), only 57 per cent of all children between 5 and 17 years of age attended school. By the turn of the century this had risen to 76 per cent, by 1920 to 82 per cent, and by 1960 to 89 per cent.

It was as low as this in 1960 only because children were starting school at 6 years of age instead of at 5. Nearly 97 per cent of all children. between 7 and 17 years of age were in school in 1960. Even more dramatic are the fig ures on schooling at a higher level. In 1870, only 2 per cent. of the relevant age group graduated from high school. This tripled to 6 per cent by 1900, tripled again to 17 per cent by 1920, and again to 50 per cent by 1940.· It had reached 62 per cent by 1956. En rollment in institutions of higher ANNUAL INCOME GROUPS All Under $3,000Households $3,000 $3,999 79.6% 44.7% 67.0% 79.0 77.5 83.5 31.9 9.5 16.9 70.0 49.8 60.9 82.6 75.0 76.8 One or more cars TV, B&W TV, Color Washingmachine Refrig.or freezer Technological Progress There can be little doubt that the technological progress of the last two generations has meant more to the families at the bottom of this pyramid than to those at the top. It is the overwhelming majority of Americans that now enjoy the advantages of running water, central heating, telephones, automobiles, refrigerators, wash ing machines, phonographs, ra dios, television sets - amenities that millionaires and kings did not enjoy a few generations ago.

Here are some of the figures of the percentage of American house holds owning cars and appliances in 1969: 614 THE FREEMAN October education junior colleges, col leges, and universities - was less than 2 per cent of the relevant age group in 1870, and more than 30 per cent in 1960.9 Serving the Masses The long-run historical tendency of capitalism has been to benefit the masses even more than the rich. Before the Industrial Revo lution the prevailing trades ca tered almost exclusively to the wants of the well-to-do. But mass production could only succeed by catering to the needs of the masses. And this could be done only by dramatically reducing the costs and prices of goods to bring them within the buying power of the masses. So modern capitalism benefited the masses in a double way - both by greatly increasing the wages of the· masses of work ers and greatly reducing the real prices they had to pay for what was produced.

Under the feudal system, and nearly everywhere before the In dustrial Revolution, a man's eco nomic position was largely deter mined by the economic position of his parents. To what extent is this true in the United States of the present day? This is a difficult 9 Author's source: Rose D. Friedman, Poverty: Definition and Perspective (Washington: American Enterprise In stitute, 1965), p. 11. question to answer in quantitative terms, because one of the intangi bles a man tends to "inherit" from his parents is his educational level, which so largely influences his adult earning power. But some of the partial answers we do have to this question are surprising. Her man P. Miller tells us: "In 1968 fewer than one family out of a hundred in the top income group lived entirely on unearned income-interest, dividends, rents, royalties, and the like. The. other ninety-nine· did paid work or were self-employed in a business or pro fession. Nearly all of these fam ilies were headed by a man who worked at a full-time job. In 1968 over four-fifths of these men worked full time throughout the year."lO They also seemed to work longer hours than the average worker.

Among the rich, also, "relatively few admit to having inherited a substantial proportion of their assets. Even among the very rich - those with assets of $500,000 or more-only one-third reported that they had inherited a substantial proportion of their assets; 39 per cent claimed to have made it en tirely on their own, and an addi tional 24 per cent admitted to hav ing inherited a small proportion of their assets."ll 10 Rich Man, Poor Man, p. ·150. 11 Ibid. p. 157.

1971 THE DISTRIBUTION OF INCOME 615 International Comparisons I have said nothing so far of the comparison of American in comes with those of other nations. In absolute figures - in gross na tional product per capita, in own ership of passenger cars and TV sets, in use of telephones, in work ing time required to buy a meal these comparisons have been all heavily in favor of the United States. In 1968, the per capita gross national product of the country came to $4,379, compared with $3,315 in Sweden, $2,997 in Canada, $2,537. in France, $1,861 in the United Kingdom, $1,418 in Italy, $1,404 in Japan, $566 in Mexico, and $80 in India. 12 More immediately relevant to our subject is a comparison of the distribution of income in the United States with that in other countries. In this respect also the result has been largely in favor of the United States. A compari son of conditions in the 1950's made by Simon Kuznets found that the top 5 per cent of families recei ved 20 per cent of the U. S.

national income. Industrialized countries like Sweden, Denmark, and Great Britain showed approx imately the same percentage. It was in the "underdeveloped" coun tries .where the greatest internal disparities existed in incomes. For 12 Statistical Abstract of the United States, 1970, p. 810. example, in EI Salvador the top 5 per cent of families received 36 per cent of the national income, in Mexico 37 per cent, in Colombia 42 per cent. This comparison is one more evidence that capitalism and industrialization tend to re duce inequalities of income. I have entitled this article "The Distribution of Income," and have been using that phrase through out; but I have done so with re luctance. The phrase is mislead ing. It implies to many people that income is first produced, and then "distributed"- according to some arbitrary and probably unjust ar rangement. A Misleading Phrase Something like this idea ap pears to have been in the back of the minds of the older economists who first began to arrange their textbooks under these headings.

Thus, Book I of John Stuart Mill's Principles of Political Economy (1848) is entitled "Production," and Book II, "Distribution." Mill wrote, at the beginning of this second book: "The principles which have been set forth in the first part of this Treatise are, in certain respects, strongly distinguished from those on the consideration of which we are now about to enter. The laws and conditions of the production of wealth partake of the character 616 THE FREEMAN October of physical truths.' There is noth ing optional or arbitrary in them .... "It is not so with the Distribu tion of Wealth. That is a matter of human institution solely. The things once there, mankind, indi vidually or collectively, can do with them as they like. . . . The dis tribution of wealth, therefore, de pends on the laws and customs of society." This distinction, if not alto gether false, is greatly overstated.

Production in a great society could not take place - on the farms, in the extraction of raw mate rials, in the many stages of proc essing into finished goods, in trans portation, marketing, saving, capi tal accumulation, guidance by price and cost and supply and de mand - without the existence of security, la\v and order, and rec ognized property rights -the same rules and laws that enable each to keep the fruits of his labor or enterprise. Goods come on the mar ket as the property of those who produced them. They are not first produced and then distributed, as they would be in some imagined socialist society. The "things" are not "once there." The period of production is never completed, to be followed by some· separate pe riod of distribution. At any given moment production is in all stages. In the automobile industry, for example, some material is being mined, some exists in the form of raw mate.rials, some in finished or semifinished parts; some cars are going through the assembly line, some are on the factory lots await ing shipment, some are in trans port, some are in dealers' hands, some are being driven off by the ultimate buyers; most are in use, in various stages of depreciation and wear and need of replacement.

Everyone Gains In brief, production, distribu tion, and consumption all go on continuously and concurrently. What is produced, and how much of it, and by what method, and by whom, depends at all times on the relative sums that those engaged in the process are receiving or ex pect to receive in profits or wages or other compensation. Production depends no less than distribution on "the laws and customs of so ciety." If farmer Smith raises 100 bushels of potatoes and farmer Jones 200 bushels, and both sell them for the same price per bushel, Jones does not have twice as much income as Smith because it has been "distributed" to him. Each has got the market value of what he produced. It would be better to speak of the variation between individual incomes than of their "distribu tion." I have used the latter term 1971 THE DISTRIBUTION OF INCOME 617 only because it is customary and therefore more readily understood.

But it can be, to repeat, seriously misleading. It tends to lead to the prevalent idea that the solution to the problem of poverty consists in finding how to expropriate part of the income of those ·who· have earned "more than they need" in order to "distribute" it to those who have not earned enough. The real solution to the problem of poverty, on the contrary, consists in finding how to increase the em ployment and earning power of the poor. , IDEAS ON ~ LIBERTY Next Month: The Story of Negro Gains The Civilizing Process AT THIS STAGE in history even the most highly civilized among us wear only a thin veneer of civilization. This can be tested easily by trying to take from our civilized fellowman something that he values highly. It is likely that his thin veneer of civilization will become even thinner. Could we not then all agree that the object of the game is, as we live, to try to contribute to, not take away from, the civilizing process?

Here in America, for reasons known to most, but apparently not all of us, men have developed a political and economic system that works better,than any other in history. It works, functions, better because it affords the opportunity for each man to rise as high as ability, talent, training and energy can take him. Every American, if he tries, can do better in the world than his father did before him, because the opportunities in America are con stantly increasing and expanding. This freedom to rise, multiplied. by the countless millions of Americans who have used it, has built (and continues to build) the economic miracle of history, a nation with the most stable institutions in history. It should be unnecessary to say that all Americans, black and white, have far more to gain by using and being a part of the system than by pulling and working against it. FRANK WALLACE, from the pamphlet, "To Insure Domestic Tranquility," copyright 1971.