Lorenz curve, Gini coefficient, family income

A. Dragulescu

V. M. Yakovenko

English

Research Papers in Economics

Physica A 299 (2001) 213–221
www.elsevier.com/locate/physa
Exponential and power-law probability
distributions of wealth and income in the United
Kingdom and the United States
Adrian Dr  agulescu, Victor M. Yakovenko∗;1
Department of Physics, Center for Superconductivity Research, University of Maryland,
College Park, MD 20742-4111, USA
Abstract
We present the data on wealth and income distributions in the United Kingdom, as well as on
the income distributions in the individual states of the USA. In all of these data, we  nd that the
great majority of population is described by an exponential distribution, whereas the high-end
tail follows a power law. The distributions are characterized by a dimensional scale analogous
to temperature. The values of temperature are determined for the UK and the USA, as well as
for the individual states of the USA. c   2001 Elsevier Science B.V. All rights reserved.
PACS: 87.23.Ge; 89.90.+n; 02.50.−r
Keywords: Econophysics; Wealth; Income; Boltzmann; Gibbs; Pareto
1. Introduction
The study of wealth and income distributions has a long history. Pareto [1] proposed
in 1897 that wealth and income distributions obey universal power laws. Subsequent
studies have often disputed this conjecture (see a systematic survey in the World Bank
research publication [2]). Mandelbrot [3] proposed that the Pareto law applies only
asymptotically to the high ends of the distributions. Many researchers tried to deduce
the Pareto law from a theory of stochastic processes. Gibrat [4] proposed in 1931
that income and wealth are governed by multiplicative random processes, which result
∗ Corresponding author. Tel.: +1-301-405-6151; fax: +1-301-314-9465.
E-mail address: yakovenk@physics.umd.edu (V.M. Yakovenko).
1 http:==www2.physics.umd.edu=∼yakovenk=
0378-4371/01/$-see front matter c   2001 Elsevier Science B.V. All rights reserved.
PII: S0378-4371(01)00298-9214 A. Dr  agulescu, V.M. Yakovenko/Physica A 299 (2001) 213–221
in a log–normal distribution. These ideas were later followed, among many others, by
Montroll and Shlesinger [5]. However, already in 1945 Kalecki [6] pointed out that the
log–normal distribution is not stationary, because its width increases in time. Modern
econophysicists [7–10] also use various versions of multiplicative random processes in
theoretical modeling of wealth and income distributions.
Unfortunately, numerous recent papers on this subject do very little or no compar-
ison at all with real statistical data, much of which is widely available these days on
the Internet. In order to  ll this gap, we analyzed the data on income distribution in
the United States (US) from the Bureau of Census and the Internal Revenue Service
(IRS) in Ref. [11]. We found that the individual income of about 95% of population
is described by the exponential law. The exponential law, also known in physics as
the Boltzmann–Gibbs distribution, is characteristic for a conserved variable, such as
energy. In Ref. [12], we argued that, because money (cash) is conserved, the prob-
ability distribution of money should be exponential. Wealth can increase or decrease
by itself, but money can only be transferred from one agent to another. So, wealth is
not conserved, whereas money is. The di erence is the same as the di erence between
unrealized and realized capital gains in stock market.
Unfortunately, we were not able to  nd data on the distribution of money. On
the other hand, we found data on wealth distribution in the United Kingdom (UK),
which are presented in this paper. Also presented are the income distribution data for
the UK and for the individual states of the USA. In all of these data, we  nd that
the great majority of population is described by an exponential distribution, whereas the
high-end tail follows a power law.
2. Wealth distribution in the United Kingdom
In this section, we discuss the cumulative probability distribution of wealth N(w)=
(the number of people whose individual wealth is greater than w)=(the total number
of people). A plot of N vs. w is equivalent to a plot of person’s rank in wealth
vs. wealth, which is often used for top reach people [13]. We will use the power
law, N(w)˙1=w , and the exponential law N(w)˙exp(−w=W), to  t the data. These
distributions are characterized by the exponent   and the “temperature” W. The cor-
responding probability densities, P(w)=− dN(w)=dw, also follow a power law or an
exponential law. For the exponential law, it is also useful to de ne the temperatures
W (2) (also known as the median) and W (10) using the bases of 1
2 and 1
10: N(w)˙
(1
2)w=W
(2)
˙( 1
10)w=W
(10)
.
The distribution of wealth is not easy to measure, because people do not report their
total wealth routinely. However, when a person dies, all assets must be reported for the
purpose of inheritance tax. Using these data and an adjustment procedure, the British
tax agency, the Inland Revenue (IR), reconstructed wealth distribution of the whole
UK population. In Fig. 1, we present the 1996 data obtained from their Web site [14].
The left panel shows the cumulative probability as a function of the personal total netA. Dr  agulescu, V.M. Yakovenko/Physica A 299 (2001) 213–221 215
Fig. 1. Cumulative probability distribution of total net capital (wealth) shown in log–log (a), log–linear
(inset), and Lorenz (b) coordinates. Points: the actual data. Solid lines: left panel— ts to the exponential
(Boltzmann–Gibbs) and power (Pareto) laws, right panel—function (2) calculated for the exponential law.
capital (wealth), which is composed of assets (cash, stocks, property, household goods,
etc.) and liabilities (mortgages and other debts). The main panel illustrates in the log–
log scale that above 100 k$ the data follow a power law with the exponent  =1:9.
The inset shows in the log–linear scale that below 100 k$ the data is very well  tted
by an exponential distribution with the temperature WUK =59:6k $ (W
(2)
UK =41:3k $ and
W
(10)
UK =137:2k $).
The right panel of Fig. 1 shows the so-called Lorenz curve [2,11] for wealth distri-
bution. The horizontal and vertical coordinates are the cumulative population x(w) and216 A. Dr  agulescu, V.M. Yakovenko/Physica A 299 (2001) 213–221
the cumulative wealth y(w):
x(w)=
 w
0
P(w )dw ;y (w)=
 w
0
w P(w )dw 
 ∞
0
w P(w )dw  : (1)
The points represent the actual data, whereas the solid line is calculated for a purely
exponential distribution [11]:
y=x +( 1− x)ln(1− x) : (2)
One can see that the data systematically deviate from the exponential law because of the
wealth concentrated in the power-law tail; however, the deviation is not very big. The
so-called Gini coe cient [2,11], which measures the inequality of wealth distribution,
has increased from 64% in 1984 to 68% in 1996 [14]. This value is bigger than the
Gini coe cient 50% for a purely exponential distribution [11]. The inequality of the
US income distribution was also increasing during that time period [11].
3. Income distribution in the United Kingdom
We obtained the data on the yearly income distribution in the UK for 1997=1998
and 1998=1999 from the Web site of the IR [15]. The data for 1994=1995, 1995=1996,
and 1996=1997 were taken from the Annual Abstract of Statistics derived from the IR
[16]. The data for these 5 years are presented graphically in Fig. 2. In the upper inset
of the left panel, the original raw data for the cumulative distribution are plotted in
log–linear scale. For not too high incomes, the points form straight lines, which implies
the exponential distribution N(r)˙exp(−r=R), where r stands for income (revenue),
and R is the income “temperature”. However, the slopes of these lines are di erent for
di erent years. The temperatures for the years 1994=1995, 1995=1996, 1996=1997, and
1997=1998 di er from the temperature for 1998=1999, R
(98=99)
UK =11:7k $ (R
(2)
UK =8:1k $
and R
(10)
UK =26:9k $), by the factors 0.903, 0.935, 0.954, and 0.943. To compensate
for this e ect, we rescale the data. We divide the horizontal coordinates (incomes) of
the data sets for di erent years by the quoted above factors and plot the results in
log–log scale in the main panel and log–linear scale in the lower inset. We observe
scaling: the collapse of points on a single curve. Thus, the distributions Ni(r) for
di erent years i are described by a single function f(r=Ri). The main panel shows
that this scaling function f follows a power law with the exponent  =2:0–2.3 at high
incomes. The lower inset shows that f has an exponential form for about 95% of
individuals with lower incomes. These results qualitatively agree with a similar study
by Cranshaw [17]. He proposed that the P(r) data for lower incomes are better  tted by
the Gamma distribution  (r)˙r  exp(−r=R). For simplicity, we chose not to introduce
the additional  tting parameter  .
We must mention that the individuals with income below a certain threshold are not
required to report to the IR. That is why the data in the lower inset do not extend
to zero income. We extrapolate the straight line to zero income and take the interceptA. Dr  agulescu, V.M. Yakovenko/Physica A 299 (2001) 213–221 217
Fig. 2. Cumulative probability distributions of yearly individual income in the UK shown as raw data (top
inset) and scaled data in log–log (a), log–linear (lower inset), and Lorenz (b) coordinates. Solid curve:  t
to function (2) calculated for the exponential law.
with the vertical axis as 100% of individuals. Thus, we imply that the IR data does
not account for about 25–27% of individuals with income below the threshold.
The Lorenz curve for the distribution of the UK income is shown in the right panel
of Fig. 2. We treat the number of individuals below the income threshold and their
total income as adjustable parameters, which are the horizontal and vertical o sets of
the coordinates origin relative to the lowest known data point. These parameters are
chosen to  t the Lorenz curve for the exponential law (2) shown as the solid line. The218 A. Dr  agulescu, V.M. Yakovenko/Physica A 299 (2001) 213–221
 t is very good. The horizontal o sets are 28–34%, which is roughly consistent with
the numbers quoted for the lower inset of the left panel.
4. Income distribution in the United States
We obtained the data on distribution of the yearly individual income in 1998 for each
of the 50 states and the District of Columbia that constitute the USA from the Web site
of the IRS [18]. We plot the original raw data for the cumulative distribution of income
in log–linear scale in the upper inset of the left panel of Fig. 3. The points spread
signi cantly, particularly at higher incomes. For example, the fraction of individuals
with income greater than 1 M$ varies by an order of magnitude between di erent states.
However, after we rescale the data in the manner described in the preceding section,
the points collapse on a single curve shown in log–log scale in the main panel and log–
linear scale in the lower inset. The open circles represent the US average, obtained by
treating the combined data for all states as a single set. We observe that the distribution
of higher incomes approximately follows a power law with the exponent  =1:7±0:1,
where the ±0:1 variation includes 70% of all states. On the other hand, for about
95% of individuals with lower incomes, the distribution follows an exponential law
with the average US temperature RUS =36:4k $ ( R
(2)
US =25:3 k$ and R
(10)
US =83:9 k$).
The temperatures of the individual states di er from RUS by the amounts shown in
Table 1. For example, the temperature of Connecticut (CT) is 1.25 times higher and
the temperature of West Virginia (WV) is 0.78 times lower than the average US
temperature.
The Lorenz plot for all states is shown in the right panel of Fig. 3 together with
the solid curve representing Eq. (2). The majority of points are well clustered and
are not too far from the solid curve. The exceptions are Wyoming (WY) with much
higher inequality and the Washington state (WA) with noticeably lower inequality of
income distribution. The average US data, shown by open circles, is consistent with
our previous results [11]. Unlike in the UK case, we did not make any adjustment
in the US case for individuals with income below the threshold, which appears to be
su ciently low.
5. Discussion
We found scaling in the cumulative probability distributions N(r) of individual in-
come r derived from the tax statistics for di erent years in the UK and for di erent
states in the US. The distributions Ni(r) have the scaling form f(r=Ri), where the scale
Ri (the temperature) varies from one data set i to another, but the scaling function f
does not. The function f has an exponential (Boltzmann–Gibbs) form at the low end,
which covers about 95% of individuals. At the high end, it follows a power (Pareto)
law with the exponents about 2.1 for the UK and 1.7 for the US. Wealth distributionA. Dr  agulescu, V.M. Yakovenko/Physica A 299 (2001) 213–221 219
Fig. 3. Cumulative probability distributions of yearly individual income for di erent states of the USA shown
as raw data (top inset) and scaled data in log–log (a), log–linear (lower inset), and Lorenz (b) coordinates.
Solid curve: function (2) calculated for the exponential law.
Table 1
Deviations of the state temperatures from the average US temperature
CT NJ MA MD VA CA NY IL CO NH AK DC DE MI WA MN GA
25% 24% 14% 14% 9% 9% 7% 6% 6% 5% 5% 5% 4% 4% 2% 1% 0%
TX RI AZ PA FL KS OR HI NV NC WI IN UT MO VT TN NE
−1% −3% −3% −3% −4% −5% −6% −7% −7% −7% −8% −8% −9% −9% −9% −11% −12%
OH LA AL SC IA WY NM KY ID OK ME MT AR SD ND MS WV
−12% −13% −13% −13% −14% −14% −14% −14% −15% −16% −16% −19% −19% −20% −20% −21% −22%220 A. Dr  agulescu, V.M. Yakovenko/Physica A 299 (2001) 213–221
in the UK also has a qualitatively similar shape with the exponent about 1.9 and the
temperature WUK =60k$. Some of the other values of the exponents found in literature
are 1.5 proposed by Pareto himself ( =1:5), 1.36 found by Levy and Solomon [13]
for the distribution of wealth in the Forbes 400 list, and 2.05 found by Souma [19] for
the high end of income distribution in Japan. The latter study is similar to our work
in the sense that it also uses tax statistics and explores the whole range of incomes,
not just the high end. Souma [19]  nds that the probability density P(r) at lower
incomes follows a log–normal law with a maximum at a nonzero income. This is in
contrast to our results, which suggest that the maximum of P(r) is at zero income.
The discrepancy may be due to the high threshold for tax reporting in Japan, which
distorts the data at the low end. On the other hand, if the data is indeed valid, it may
re ect the actual di erence between the social structures of the US=UK and Japan.
The income temperature for the UK in 1998=1999 was RUK =11:7k $ and for the
US in 1998 was RUS =36:4 k$. Using the exchange rate as of December 31, 1998 to
convert pounds into dollars [20], we  nd that the UK temperature was RUK =19:5k $ ,
which is 1.87 times lower than the US temperature. The di erence in temperatures
indicates nonequilibrium, which can be exploited to create a thermal machine [12].
The gain (pro t) produced by such a thermal machine is proportional to the di erence
in temperatures. In agreement with the second law of thermodynamics, money would
 ow from a high-temperature system to a low-temperature one. This may explain the
huge trade de cit of the USA in global international trade with other, lower-temperature
countries. The variation of temperatures between di erent states of the USA is shown
in Table 1.
Acknowledgements
We are grateful to Ted Cranshaw, who kindly sent us his unpublished study of
income distribution in the UK [17] and data [16], and Bertrand Roehner, who suggested
to study income distributions in the states of the USA and sent us link [18].
References
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[13] M. Levy, S. Solomon, Physica A 242 (1997) 90.
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income2000.pdf, 1997–98: http:==www.inlandrevenue.gov.uk=stats=table3 3a.htm.
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Annual Abstract of Statistics,

Cours d’Economie Politique,

Distribution of Personal Wealth, Inland Revenue,

Income Inequality and Poverty,

Individual Tax Statistics by States in

Inland Revenue, 1998–99:

Les In egalit es Economique, Sirely,

The Interactive Currency Table,

Exponential and power-law probability distributions of wealth and income in the United Kingdom and the United States

http://www2.physics.umd.edu/~yakovenk/papers/PhysicaA-299-213-2001.pdf

Exponential and power-law probability distributions of wealth and income in the United Kingdom and the United States

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