We think we are poorer than we really are
Are you a member of the 1%? If you live in the UK and your annual income before taxes is £170,000 or more, you are amongst the top 1% of Brits by income. If your annual income is £75,000 or higher, you are amongst the top 5%, an income of £53,100 puts you in the top 10% and £23,200 annual income will put you in the top half according to the HMRC.
People who work in finance – particularly in London – tend to be surprised how low these break points of the income distribution are. Effectively, if you work in finance and have more than a couple of years professional experience, you are most likely amongst the top 10% income earners in the UK. Now, if you know your position on the income ladder, does that change your views about how high taxes should be or if there should be higher taxes to help poorer members of society?
According to a 2014 study of Swedish citizens, it may, but only if you are right of centre politically.
In their study of 4,500 randomly selected Swedish citizens, Mounir Karadja, Johanna Möllerström and David Seim investigated if people have a realistic picture of their income relative to other members of a society. Sweden is particularly fertile for such studies because it has high quality data not only of income and taxes paid but also about educational attainment and, at least for men who have to fill out an IQ test when they are assessed for military service, cognitive ability. This allows for some intriguing insights into the drivers about their perception.
Our chart is taken from the research paper and shows the perceived relative income of survey participants in relation to the actual relative income. Dots below the diagonal line indicate that survey respondents perceive their income to be lower than it actually is, while dots above the diagonal line indicate people who perceive their income to be higher than it is. It turns out that in this study, 63% of the population (mostly on the higher end of the income distribution) underestimate their relative income while 8% (mostly on the lower end of the income distribution) overestimate their relative income.
What makes the study interesting is what the researchers did next. They tested if correcting this bias in perceived income would change the survey respondents’ views about taxation and income redistribution to create a more equitable society. It turns out that it does, but only with a certain subgroup of the population: people who lean conservative on the political spectrum.
Survey respondents who were leaning to the political left did not change their views about taxation or government redistribution after they were informed about their correct relative income. Conservative-leaning respondents, on the other hand became more averse to higher taxation and government redistribution. This is not due to differences in the degree of altruism or “compassion” since these attitudes were excluded as sources of this shift in the study. Rather, this difference in behaviour seems to be due to differences in the views about how the economy works and what drives economic success in life. Conservative-leaning respondents were more likely to believe that success in life was due to individual skill and effort rather than luck, compared to left-leaning respondents, and they were also more likely to believe that higher taxation reduces the incentive to work. In short, it is the political belief system that drives attitudes towards taxation and government redistribution, and these believes are reinforced if people have a more accurate sense of their income relative to other members of their society.
However, the study authors could not answer why people with higher income tend to have more conservative beliefs. They speculate that it is a self-selection mechanism where people with higher cognitive ability or high skills find it easier to succeed in life and thus lean towards a more individualistic, conservative world view. A follow-up study by Johanna Möllerström and David Saim showed that higher IQ seems to drive these differences. A one standard deviation increase in cognitive ability (15 points on a standard Wechsler or Stanford-Binet IQ test scale) leads to a reduction in willingness to redistribute income by five percentage points – the same effect as an increase of annual income by $35,000.
Biased perception of relative income
Source: Karadja et al. (2014).