What Dr. Dre Can Teach Us About Income Inequality

December 16, 2014

Andre Young, the producer, performer, and businessman known by the stage name Dr. Dre, took a commanding lead in the Forbes list of the world’s highest-paid musicians of 2014. With earnings of $620 million, he had a more than five-fold lead on the second-place musician, Beyoncé Knowles. In fact, by the Forbes data, he earned more than the next seven members of the list combined. We can think of this as a sort of income inequality story. Is Dr. Dre really doing that much better than his peers at the top of the music industry? Is his overall earning ability actually nine times greater than Taylor Swift’s? What’s going on?

The eye-popping number is an artifact of income measurement. While income is very straightforward to measure for a typical wage or salary earner, it is far more complicated for people like Dr. Dre, an entrepreneur who takes an ownership role in business ventures. For someone like Dr. Dre, annual measurements of income give a less accurate picture of how well he is doing. Taken out of context, Dr. Dre’s 2014 number from Forbes overstates his financial position relative to his peers.

Readers familiar with the music industry might know that the bulk of Dr. Dre’s income came from the $3 billion sale of his company, Beats Electronics, to Apple. Most of his earnings this year came from Apple in exchange for his substantial equity stake in Beats. The result of this transaction is a gigantic one-time spike in Dr. Dre’s measured income.

For comparison, Dr. Dre was listed at only $40 million by Forbes in 2013. Virtually all of the earnings from Beats Electronics were counted at the time it was sold. But in truth, Dr. Dre has spent about eight years working on the Beats brand. The $600 million haul from 2014 represents the culmination of a years-long project, not a single year of work, and we should understand that the credit for that income really distributes across all of the years he spent building the company.

It’s easy to look at the comparatively low measurement from 2013 and ask whether we forgot about Dre. But imputing the value of businesses that aren’t yet sold is tricky, so we typically wait until the sale in order to count that value. Dr. Dre’s income was earned over several years but realized – and hence, counted – in 2014. This mirrors an issue with measuring capital income in the U.S. at large. People put money in their brokerage accounts, invest in their small businesses, or otherwise put money aside for many years. Then they cash out in large chunks. This is just as true of many ordinary people as it is of celebrities. Such people have dramatic one-year spikes in their income, just as Dr. Dre did.

This is a problem when it comes to the measurement of inequality. A popular method of measuring inequality is cross-sectional, looking at everyone’s income for a single year. But as we see, that can produce inaccurate results. A longitudinal study – one that follows people for several years in a row – would produce more illuminating results. Some studies of that kind are available. For example, a 2010 Tax Foundation study of IRS data followed individual tax return data between 1999 and 2007. Of the people to earn more than $1 million in annual income at any time in that period, about half of them only achieved it once. The report found that the volatile nature of capital gains realizations was a major explanation for the transiency of millionaires. In other words, when you see a distributional table of individual income for a single year, it’s worth remembering that you’re just seeing a snapshot – one that overstates the affluence of some and understates the affluence of others.

This post originally appeared on Forbes.com.


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