THE NEW DEBATE OVER THE VERY RICH The top 1% of earners did better than everyone else in the 1980s, but much of the fire they draw is off target. Here's how they got it -- and why new taxes aren't the answer.
By Anne B. Fisher REPORTER ASSOCIATE Tricia Welsh

(FORTUNE Magazine) – 1% BILL BYRNE'S life story is an American classic -- humble farm boy makes good by working his tail off. He grew up on a 240-acre hog farm in Pocahontas County, Iowa, the oldest of six, and put in such arduous hours on chores that going off to college was, he recalls, ''like a vacation.'' At 25, Byrne joined Dain Bosworth, the regional investment house, and by 29 was the youngest branch manager of any NYSE-listed firm. He was also well on his way to a fortune, investing heavily in a chain of Mexican fast-food restaurants in Des Moines in the mid-1970s, a time when most Midwesterners couldn't tell a taco from an enchilada. Today, at 48, Byrne runs a multimillion-dollar mini-empire with 200 employees. It includes 13 Taco John's restaurants in Iowa, a thriving regional magazine on agribusiness, and a successful practice in human-resource consulting. Despite an annual income of more than $500,000 a year, Byrne still works hard, but he and wife Lynne have more time to enjoy the little extras money can buy -- such as a second home in the Colorado Rockies. ''In my professional life I had some failures over the years,'' he says. ''But I think I've learned more from my mistakes than my successes. You just pick up and go on. If one thing doesn't work out, try something else. Never give up.'' With his compulsion to improve himself -- he spends about 15 hours a week reading books of the how-to-be-a-super-manager variety, and recently wrote one of his own -- Byrne is a likable exemplar of a group that has lately been much maligned and politically embattled: the top 1% of income earners in the U.S. These people, whose pretax incomes for a family of four started at roughly $350,000 in 1991 and went up (and up and up), are the folks who walked off with most of the income gains of the Roaring Eighties. Census Bureau and IRS data analyzed by the Congressional Budget Office show that from 1977 through 1989 the annual take-home pay of the average American family edged up 9%, but for the lucky 1% of the population it more than doubled, to an average of $410,000. These statistics -- released in an election year -- have sparked a vigorous round of rich-bashing, particularly by Democrats. Bill Clinton peppers his campaign speeches with attacks on income inequality that draw heavily on research by Paul Krugman, an MIT economist. Krugman claims that the gap between the richest Americans and the rest of the populace has become more vast -- and, by implication, less fair -- than at any time since the Great Depression. Such talk has Bush Administration officials scurrying to defend the Republican record with statistics of their own. The sudden outbreak of populism has even inspired billionaire Ross Perot, of all people, to campaign as a champion of the middle class. WHILE CONGRESS mulls over new legislation, including a proposed 10% surtax on anyone with taxable income of more than $1 million a year, the fortunate few who fared most handsomely in the past decade might be excused some puzzlement. In a country that reveres material success, there is apparently now such a thing as being too successful. The political fracas over income inequality tends to oversimplify what is, in truth, exceedingly complex. The available statistics are slippery and full of holes. The CBO's report to the House Ways and Means Committee last December, which started the whole furor, shows that the top 1% of earners have definitely been pulling away from the pack. They hauled in 70% of the total $250 billion net increase in household incomes between 1977 and 1989. That 70% shocker is the most quoted figure around. But the CBO has since emphasized that to measure the income gains of the top 1% properly, you ought to adjust them for family size. As any parent knows, kids eat up a lot more than pizza money, and contrary to popular wisdom, high- income couples now have slightly more dependent children than they used to, while less well-off Americans have slightly fewer. Take that into account, and the share of income gains collared by the very rich drops to 44%. The CBO also notes that there's a good argument for subtracting capital gains from incomes, since in many cases these reflect one-time windfalls, such as when a retiring couple sell their $500,000 house in Connecticut and move to Florida. Do that, and the infamous 70% dwindles to 33%. In short, the richest 1% gained a lot during the roaring Eighties but far less than commonly thought. This titanic political battle is being waged over data drawn from 60,000 of the 100 million U.S. households. While that sounds small, it's a very respectable sample as these things go. Still, the data need to be handled with care. In 1989 the CBO projected income growth for 1990. It subsequently discovered capital gains income had been overestimated by $130 billion. Such whopping uncertainties suggest it would be wise to turn down the heat a bit in this debate. Blurring the statistical picture still more are data such as those the Federal Reserve recently published showing that the wealthiest 1% of U.S. families claimed 36% of household net worth in 1989, up from 31% in 1983, while everybody else's share fell slightly. Because both the CBO and the Fed studies refer to the ''top 1%,'' a casual reader might well infer that the same crowd is perched in both groups. It ain't necessarily so. There is, of course, a difference between annual income and net worth. ''Just looking at reported income figures is a very poor indicator of who is really rich and who is not,'' notes John DeMarco, senior vice president of PSI, a financial services research firm in Tampa that scrutinizes the affluent. Here's one notable example: George Bush earns a salary of $200,000, and even his additional investment income of $208,274 a year in 1989 didn't bring him up to the average annual pretax pay of the top 1% then -- $560,000. Yet with a reported net worth of about $4 million, he's wealthier than many people who in a given year may have reported twice his income to the IRS. (For more on those with the highest net worth, see the following story.) How many of the top 1%, measured by income, boast the wealth of the Bushes, the Kennedys, the Rockefellers, and the Perots? How many are self-made newcomers and how many got their money the old-fashioned way -- by inheriting it? The political relevance of these questions is obvious. If the families in the lucky 1% in 1992 are a much different crew than their counterparts in 1977, then banging the class warfare drum over their success will ring hollow to many Americans. While no one knows the answers with any precision, most experts agree -- and many of the data suggest -- that the income figures mask an extraordinary amount of dynamism. THOMAS J. STANLEY, an Atlanta consultant who has been analyzing the wealthy for 22 years, figures that about 80% of high-income Americans are first- generation, self-made successes who tend to spend what they make rather than pile up a true fortune. A new study by the Treasury Department's Office of Tax Analysis also concludes that income mobility in the U.S. is high. Treasury examined 14,351 taxpayers who filed returns in every year from 1979 to 1988. Among the top 1% in 1988, only 32% had started the decade very rich and stayed that way. The majority were newcomers. Of them, however, just 2% began the 1980s all the way down in the bottom fifth and clambered all the way up to the top. Other studies confirm some of Treasury's findings. Professors Greg J. Duncan and Willard Rogers of the University of Michigan and Syracuse University's Timothy M. Smeeding examined income data for 5,000 families over 23 years. Their conclusion: While it became somewhat harder during the 1980s for children of poor parents to climb the income ladder, it was easier during that superheated decade than in the 1970s for those in the middle to rise to the top. But what explains the outsize income gains of the very rich in the 1980s? Two things: soaring real estate prices and a sizzling stock market. The Dow Jones average more than tripled between 1980 and 1989, despite the crash of 1987. That compares with a mere 4% increase during the 1970s. This was an era in which, more than ever, having some money enabled you to make even more. Changes in tax policy also helped. The top tax rate fell from 70% in 1980 to 28% during the decade, allowing the super-rich to keep more of their rising incomes. Even so, big earners paid a heap of taxes. The CBO reports that the top 1% in 1989 paid 24.6% of all U.S. personal income taxes, up from 18.3% in 1980. By contrast, the bottom 40% of households paid just 2.1% of all 1989 income taxes, down from 3.6% in 1980. A recent cut at the data by Treasury's Office of Tax Analysis makes this point more dramatically. Adjusting for inflation, all American households combined paid $51.8 billion more in federal income taxes in 1989 than they did in 1981. But the top 1% of wage earners alone accounted for $45 billion of that increase. Besides benefiting from lower tax rates and a surging market, the very rich saw their salaries explode in the 1980s. Why? Partial answers can be found by asking another pertinent question that studies of top wage earners rarely pose: Who are the lucky 1%? They number about one million households, or fewer people than live in Chicago. Most are highly educated -- a big advantage in today's economy, in which knowledge is power. According to survey data gathered by research firm PSI, 89% are college graduates. During the 1980s, the super-rich got slightly younger, as some baby-boomers marched into the upper echelons. Their average age dropped from 53 to 51. A big majority of top one-percenters are married (84%), and about half still have kids at home. Many of the very wealthy confirm the adage that the way to get rich in America is to work for yourself. While the major exceptions -- CEOs and senior corporate managers -- are the largest single group, their representation among the very rich fell from 44% in 1981 to 31% in 1991 (see table). Still, this smaller group is even better compensated in real terms than they used to be. Raises in salary accounted for only about one-third of top managers' new booty. Credit the rest to the rampaging Dow and the newfound popularity of stock options. In 1985 the typical CEO of a medium-size American industrial company -- one with annual sales of between $500 million and $1 billion -- got long-term incentives, mainly options, worth about $58,000. Last year the figure was over $527,000 (see FORTUNE, April 6, 1992). By now CEO pay has stirred up so much popular ill will that if boards of directors don't put their collective foot down, Congress might. THE NEXT-LARGEST component of the top 1% is what PSI labels ''others,'' including entertainers, athletes, and sundry professionals, such as accountants, management consultants, and investment bankers. In 1981 ''others'' made up a tiny fraction of the top-paid Americans. By 1991 they accounted for nearly one-quarter of the top 1%. In most cases pure market forces -- measured by record and movie ticket sales, demand for a hot new business book, or corporate eagerness to pay huge fees for, say, some dynamite new strategic insight or maybe even an entire company -- propelled these folks to the top of the income charts. By 1990 even the average National Basketball Association player had dribbled into the top 1% with a $600,000 salary. Baseball, since free agency, is an even richer game. Average pay in the big leagues smoked past $1 million this year, partly owing to megadeals like slugger Bobby Bonilla's $29 million five- year contract with the New York Mets. Ball clubs have been able to afford such lavish compensation in part because of an explosion in television - revenues. The Mets, for instance, took in $38.3 million last year from CBS, ESPN, and local stations, more than any other team except the Yankees. The good fortune of the ''other'' category may dim somewhat in the 1990s. In baseball the networks could be getting ready to rain on the revenues game. Commissioner Fay Vincent warns that any team owner who isn't preparing for a drop in his cut of the TV take ''isn't in touch with reality.'' For the entertainment industry, reality has already set in. The globalization of the music and movie businesses in the 1980s, plus all those nifty royalties from VCR owners, made Hollywood hum. The recent recession has taken much of the glitter off, although a handful of hotshots still command top dollar. Superstar Jack Nicholson, 55, reportedly took home $5 million for ten days' work on A Few Good Men, which Columbia Pictures will distribute this fall. Doctors, dentists, and lawyers together account for almost a third of the very rich, about the same proportion as ten years ago. The big news here is the decline of the lawyers -- down from 19% in 1981 to 13% -- and the rise of the Hippocratic oath-takers, whose share climbed from 10% to 15%. Supply and demand may explain some of that shift. While the number of doctors rose only 43% in the 1980s, U.S. spending on health care ballooned 142%. In the years ahead, more intensive efforts to hold down medical costs may trim some of those gains. FINALLY, WE come to the segment of the lucky 1% who in most Americans' eyes are unalloyed good guys -- the founders and owners of new businesses. About 20% of the super-rich are entrepreneurs. Whatever your estimate of CEOs' or ballplayers' worth to society, there's no denying that these men and women -- capitalism's equivalent of a high-wire act with no net below -- are a breed apart, and not merely because of the risks they take. Through grueling years of work and worry, they create new enterprises, new jobs, sometimes whole new markets. And at the moment, entrepreneurs are the primary engineers of economic growth. Between 1980 and 1990, FORTUNE 500 companies shed 3.4 million jobs, but companies with fewer than 500 employees created more than 13 million. What do entrepreneurs have in common? Not much, says PSI's John DeMarco: ''The biggest income earners are iconoclasts, with a remarkably wide range of investment patterns, attitudes, and consumption habits. You really can't make too many general statements about these people.'' ( Take the couple on FORTUNE's cover. Demographically speaking, Bill and Lynne Byrne, who vaulted into the top 1% in the early 1980s, are about as typical as they could be: married, two dependent children. Still, Byrne regards himself as a lifelong maverick. ''I wouldn't be where I am now without my independence, going against the grain, not doing 'the done thing,' '' he muses. ''Self-made people are natural nonconformists.'' Often these iconoclasts are somewhat ahead of their time, acting on an idea just before it seems truly practical -- like hawking Mexican fast food in Iowa in Byrne's case, or selling a million juice machines a year to diet-conscious consumers. Juice machines? Absolutely. Meet the Cesari brothers, Steve and Rick, now living in Seattle, where they started Trillium Health Products just three years ago. It markets a $289 electric appliance called Juiceman -- as well as a smaller, $150 version, the Juiceman Jr. -- that squeezes the bejabbers out of vegetables and fruits to make a quick, healthful drink. Juicers are now about the hottest small appliance going, the Cuisinart of the 1990s, and retailers' main problem is keeping enough of them in stock. Trillium isn't the only company riding the wave, but the Cesaris say annual revenues have surged from $950,000 in 1989 to more than $75 million this year. The oldest of eight children, Steve, 38, and Rick, 35, are too young to have been among the top 1% when the CBO started counting in 1977. They grew up in suburban Westchester County, New York, working after school and on weekends in their father's grocery store -- until Dad died of a heart attack at age 48. Rick earned a premed degree in college before moving west to join a direct- mail marketing partnership. Steve went to Panama City, Florida, and started a chain of sporting goods stores. ''We've both been very much into nutrition and exercise for a long time,'' says Steve, ''and we wanted to go into business together, but it wasn't until 1989 that we saw this opportunity.'' Once they saw it, ''we hocked everything we had to raise startup capital. We even took out a home equity loan on our mother's house.'' (Mom is out of debt now.) Besides selling juicers, Trillium runs seminars on nutrition that encourage people to eat more fruits and vegetables. ''Consumption of meat is not only bad for you, it's destroying the planet,'' declares Rick. ''By changing your eating habits, you can also help save the environment.'' Trillium's 160 employees, he adds, ''believe strongly in what we're doing.'' At the company's Seattle headquarters, people don't take coffee breaks. They take juice breaks, squeezing the stuff out of 4,000 pounds of organically grown vegetables per week. Sudden success hasn't much altered the way the Cesari brothers live. Steve hauls his four kids around in a Chrysler minivan, and Rick drives a Chevy. They both spend lots of time with their families; Rick and his wife just had their first baby. The simple life is mostly a result of some distinctly post- Reaganite soul-searching. ''In the 1980s I did pretty well in direct marketing, and the first thing I did was buy myself a Porsche convertible,'' says Rick. ''Then that business went south, and I had already realized that material things weren't the answer anyway. The second time around, starting a business, you feel like you have to contribute something.'' SOUND CORNY? Maybe, but consider this: When people from middle-class backgrounds suddenly find themselves in high cotton, they can come unhinged in a big way. A mission, a sense that life has some larger purpose, whatever one perceives that to be, is a powerful antidote to confusion and despair. Ask Michael Stolper, a money manager in San Diego who acts as a kind of amateur therapist and father confessor to 400 high-income clients. They trust him with some $3 billion of their assets, and many of their personal secrets too. ''A big income is a two-edged sword,'' says Stolper. ''People get seduced by money, but no matter how much you make, deep down you know you're the same schlub you always were. It's a shrink's bonanza.'' The most contented among the top 1%, say Stolper and others, share two traits. First, they earn their money by doing something they truly love, so that the cash is just the frosting on the cake, a byproduct of their efforts rather than an end in itself. Second, they have a strong sense of a meaning in life that transcends the workaday routine of getting and spending. The Cesaris, who donate cash and juicers to the homeless and other causes, find that larger purpose in promoting health and saving the planet. People like Elizabeth Clemmer find it in religious faith. Clemmer, 41, and two partners started Focus 21 International ten years ago. It now has 182 employees. Focus 21 makes biodegradable, non-animal-tested hair and skin care products in a 90,000-square-foot plant in Vista, California, and sells them to more than 100,000 haircutting salons across the U.S. and Canada. No unworldly ascetic, Clemmer spends a lot of time on her 60-foot yacht, the Tango Amour. Yet, says she, ''I have a strong relationship with God and feel very close to him in my life. I feel very blessed. Everybody has his or her own truth. But I really feel that no matter how much money people have, without a solid spiritual connection, they tend to be kind of . . . lost.'' An active churchgoer, Clemmer five years ago began putting her beauty- business expertise into assisting people in need. With the help of nonprofit groups, she persuaded department stores like Saks and Neiman Marcus to donate time, talent, and clothes for a series of fashion shows to benefit cancer and AIDS research, the Children's League, the homeless, muscular dystrophy, and several West Coast hospitals. The shows have raised hundreds of thousands of dollars, but Clemmer insists it's no big deal: ''I love doing this. It's a great way to have fun and do good at the same time.'' Such laudable private generosity won't do much to assuage public animosity toward the top 1%. The widening abyss between the super-rich and everyone else, overstated and misunderstood though it may be, is real. Question is, will it continue to worsen? Probably not. For one thing, the tax increases contained in the 1990 budget deal that George Bush struck with Democrats in Congress have already blunted the effect of some of the Reagan-era cuts. Nor are the stock and real estate markets likely to deliver such stunning gains in the decade ahead. Demographic shifts are also likely to make more Americans feel, if not rich, at least considerably better off. In a report released last spring, the Conference Board, a business research organization, notes that because vast hordes of Americans are reaching their peak earning and spending years in the 1990s, ''total personal income flowing to the nation's consumers will be growing a lot more quickly than the population.'' The study predicts that average household income will rise by 15% in the 1990s, up from 11% in the 1980s. Better still, several million families will ascend from the lower income brackets to the middle, and even more middle-class families will achieve affluence than did so in the 1980s. Significantly, the best-educated workers will have the biggest edge. Income in families headed by college graduates, the Conference Board study says, will rise 35% during the 1990s, compared with a 25% increase for the population as a whole. By the end of the decade, such college-educated families will account for 25% of the population but will earn 40% of all personal income. YOU'VE HEARD IT before, but the most powerful explanation for the growth in income inequality -- a phenomenon that afflicts all developed economies and not just the U.S. -- is that in the age of the microchip, high-paying jobs for low-skilled workers are gone. Continued economic growth -- the kind that raises all boats and not just those flying yacht-club flags -- will hinge upon a society's ability to generate a steady supply of educated employees. Attempting to close the income gap by raising taxes on the rich is attacking the wrong problem with a blunt instrument, one that could have unpleasant side effects, such as discouraging savings and investment. (The truly wealthy, after all, can always switch from realizing their capital gains to, say, clipping more coupons from their tax-free municipal bonds.) Instead, policymakers should be directing most of their attention to how they can help better educate, train, and retrain American workers. Where is that post-Cold War peace dividend anyhow? And what more constructive way to spend it than by putting more government money to work where it's needed most? Some prime candidates: Head Start programs, inner-city schools (nearly 20% of U.S. high school students drop out before graduation), and college loans and scholarships. As for what you can do about closing your personal wealth gap, you could do worse than to listen to consultant Thomas Stanley. ''The quest for status -- expensive cars, a second home, a country club membership, and so on -- is the single biggest reason why a high income does not usually translate into real wealth, '' he says. ''Any family can rise from middle-class to rich in this country by forgoing status, even for just one generation, and investing instead.'' Want to be really rich someday? Get educated, work hard -- and resist the urge to splurge.