Author Topic: Does self-employment on average deliver a higher income?  (Read 750 times)

SeattleCPA

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Does self-employment on average deliver a higher income?
« on: January 18, 2023, 04:48:16 PM »
I only recently discovered the data visualizer that's now part of the Fed's Survey of Consumer Finances. It is a great tool to use to look at that data in pictures.

Here's link to visualizer: https://www.federalreserve.gov/econres/scf/dataviz/scf/chart/#series:Before_Tax_Income;demographic:occat1;population:all;units:median

Here is a picture of the earnings over time from various occupational categories. It shows self-employment generates a nice premium though that premium fluctuates obviously.


Metalcat

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Re: Does self-employment on average deliver a higher income?
« Reply #1 on: January 18, 2023, 04:58:32 PM »
Self employed income data is necessarily biased with survivorship bias of only including those those succeed at being self employed.

So yes, on average, people who have the ability to sustain self-employment income tend to do better than people who are employed.

But that doesn't account for the enormous number of the self-employed people who rapidly fail.

It's a bit of an apples to oranges kind of thing.

Michael in ABQ

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Re: Does self-employment on average deliver a higher income?
« Reply #2 on: January 18, 2023, 05:00:50 PM »
It would be interesting to see that data with bars showing the 5% to 95% percentile, or even 25% to 75% percentile. I imagine self-employed would be a lot wider than employee (higher highs and lower lows).

On paper my income has dropped since switching to self-employed - at least what's hitting my personal bank account. But that's because most of the business profits have stayed in the business to fund additional growth.

FIPurpose

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Re: Does self-employment on average deliver a higher income?
« Reply #3 on: January 18, 2023, 05:01:30 PM »
Skimmed the article and it doesn't say that they took self-employed people's additional FICA taxes into consideration. That almost completely wipes out any "premium". Add in the additional labor that self-employed people do that they don't charge for, and this makes employees actually look like the better choice.

Alternatepriorities

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Re: Does self-employment on average deliver a higher income?
« Reply #4 on: January 18, 2023, 05:11:16 PM »
It looks like there is a significant and so far permanent drop in the self employment premium and earnings starting around 2010. I can't help but wonder if that's not tied to the rise of things like Uber. Maybe for making it just as easy to be "self employed" as to have a w2 job the "gig" companies are keeping the difference?  Or, maybe they've just made it possible to be self employed in a practical way at a lower hourly rate?

SeattleCPA

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Re: Does self-employment on average deliver a higher income?
« Reply #5 on: January 19, 2023, 06:58:42 AM »
Self employed income data is necessarily biased with survivorship bias of only including those those succeed at being self employed.

So yes, on average, people who have the ability to sustain self-employment income tend to do better than people who are employed.

But that doesn't account for the enormous number of the self-employed people who rapidly fail.

It's a bit of an apples to oranges kind of thing.

Your first argument is the popular wisdom. But I've argued for a long time that it's misleading.

For one thing, it assumes someone only gets one "at bat." E.g., if there's a 50% chance of failure in a venture, you assume someone's chance of succeeding at self-employment equals 50%. But if someone makes two attempts or three? Or what if someone smart and disciplined makes two or three attempts.

Why is the chance they will fail not more like 50% times 50%? (So 25%?) Or 50% times 50% times 50%? (So 12.5%?)

The other thing is the data presumably include the failures. So those are averaged in. They're grouping all the self-employed people, successful and unsuccessful. New and old.

One other philosophical point: The "most people fail" argument can be applied to a bunch of pursuits: Attending a selective university. Applying to medical school or dental school. Starting a Ph.D. program. Just an observation.

P.S. I don't say this to change your mind. I'm responding for benefit of folks who think about self-employment and entrepreneurship as career options.

« Last Edit: January 19, 2023, 07:19:35 AM by SeattleCPA »

SeattleCPA

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Re: Does self-employment on average deliver a higher income?
« Reply #6 on: January 19, 2023, 07:01:34 AM »
It would be interesting to see that data with bars showing the 5% to 95% percentile, or even 25% to 75% percentile. I imagine self-employed would be a lot wider than employee (higher highs and lower lows).

On paper my income has dropped since switching to self-employed - at least what's hitting my personal bank account. But that's because most of the business profits have stayed in the business to fund additional growth.

@Michael in ABQ , I agree it'd be interesting to see the range. Intuitively it should be wider. Probably similar to the way an equities heavy or all equities portfolio shows on average better returns but also a wider range of returns.

One other thing to keep in mind: You and I get hopefully better at what we do in our businesses and should make more as we gain skills and as strategic advantages snowball. Also, if your business's value grows, that's part of your income.
« Last Edit: January 19, 2023, 07:22:44 AM by SeattleCPA »

SeattleCPA

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Re: Does self-employment on average deliver a higher income?
« Reply #7 on: January 19, 2023, 07:05:52 AM »
Skimmed the article and it doesn't say that they took self-employed people's additional FICA taxes into consideration. That almost completely wipes out any "premium". Add in the additional labor that self-employed people do that they don't charge for, and this makes employees actually look like the better choice.

You might be right, @FIPurpose. But I'm also not sure that the numbers don't make an apples to apples comparison here. When people argue about the taxes middle-class workers pay, for example, I'm pretty sure the commonly agreed on accounting says that an employee in effect pays all the FICA.

Also, you may not know this but small business owners are very effective at minimizing their FICA taxes. For example:

https://evergreensmallbusiness.com/tax-strategy-tuesday-one-person-s-corporation/
« Last Edit: January 19, 2023, 07:20:53 AM by SeattleCPA »

SeattleCPA

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Re: Does self-employment on average deliver a higher income?
« Reply #8 on: January 19, 2023, 07:18:34 AM »
It looks like there is a significant and so far permanent drop in the self employment premium and earnings starting around 2010. I can't help but wonder if that's not tied to the rise of things like Uber. Maybe for making it just as easy to be "self employed" as to have a w2 job the "gig" companies are keeping the difference?  Or, maybe they've just made it possible to be self employed in a practical way at a lower hourly rate?

Good point, @Alternatepriorities. And definitely worth watching. I would for one question the business ownership returns on any of the 1099 gig worker business models: Uber, Lyft, Ffiver, elance, etc. Ditto for MLM models like pampered chef, nutrilife, amway, etc.

One wants to entrepreneur in a field where one is delivering a complex service or product.

I keep pointing to the study that came out a few years ago and which I've read several times: Capitalists in the Twenty-first Century. The economists who wrote the paper and did the research--Matthew Smith, Danny Yagan, Owen M. Zidar and Eric Zwick--really describe how you want to be an entrepreneur to earn a high income and create lots of economic value for your community. This is a great read even if the material is a little dense.

P.S. I tried to discuss the "capitalists" paper in terms of small business entrepreneurship here: Human Capitalists in the Twenty-first Century.

« Last Edit: January 19, 2023, 07:21:14 AM by SeattleCPA »

Metalcat

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Re: Does self-employment on average deliver a higher income?
« Reply #9 on: January 19, 2023, 07:47:38 AM »
Self employed income data is necessarily biased with survivorship bias of only including those those succeed at being self employed.

So yes, on average, people who have the ability to sustain self-employment income tend to do better than people who are employed.

But that doesn't account for the enormous number of the self-employed people who rapidly fail.

It's a bit of an apples to oranges kind of thing.

Your first argument is the popular wisdom. But I've argued for a long time that it's misleading.

For one thing, it assumes someone only gets one "at bat." E.g., if there's a 50% chance of failure in a venture, you assume someone's chance of succeeding at self-employment equals 50%. But if someone makes two attempts or three? Or what if someone smart and disciplined makes two or three attempts.

Why is the chance they will fail not more like 50% times 50%? (So 25%?) Or 50% times 50% times 50%? (So 12.5%?)

The other thing is the data presumably include the failures. So those are averaged in. They're grouping all the self-employed people, successful and unsuccessful. New and old.

One other philosophical point: The "most people fail" argument can be applied to a bunch of pursuits: Attending a selective university. Applying to medical school or dental school. Starting a Ph.D. program. Just an observation.

P.S. I don't say this to change your mind. I'm responding for benefit of folks who think about self-employment and entrepreneurship as career options.

The data doesn't include the failures though because the failures quickly self-select themselves out of the data.

Anyone who is reporting ongoing self-employed income is someone who is succeeding at making an income self-employed.

A LOT of self employed people fail within a few years, especially those starting businesses.

Meanwhile, most people who secure employment tend to stay employed. It is much more probable that someone just continues to collect a paycheque than that someone successfully starts their own business and makes money off of it for years on end.

I get your point, but I come from a family of almost entirely small business owners, I've always been self-employed, and as a side hustle have worked (self-employed) in the finance world specifically advising self-employed people. One of my closest friends also specifically researches self-employment data for the government. So my perspective on this is fairly reasonably informed and not at all biased against self-employment.

My point is not that other data doesn't have survivorship bias baked in, of course it does, and I'm often the first person to argue that. My point is that when comparing employee income on average to self-employed income, you will see a significant impact of that survivorship bias because A LOT of the people who fail at self-employment will end up back on the employment side of the equation.

The big difference in comparing the two is that someone who fails in their professional goals as an employee usually still stays an employee making less money than they had hoped.

Someone who fails at self-employment doesn't usually just make less money than they had hoped, they usually leave self-employment altogether.

This makes comparing the two misleading.
« Last Edit: January 19, 2023, 07:49:51 AM by Metalcat »

SeattleCPA

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Re: Does self-employment on average deliver a higher income?
« Reply #10 on: January 19, 2023, 08:27:02 AM »
I think you need to quantify the effect of your first three points. And then also to be fair quantify the effect of those same issues for, say, people who want to go to medical school and become a doctor. Or people who want to get a Ph.D. and become a college professor.

All that said, we obviously interpret the data and our experiences differently. And a good discussion only helps others following this discussion make better choices. So truly appreciate your comments and perspective.

P.S. I don't know if you've ever seen or read Scott Shane's book, Illusions of Entrepreneurs. But it makes arguments similar to those you're making. Here's my rebuttal to Professor Shane's points. Illusions of Entrepreneurship Professors.

P.P.S. I think you ought to consider adjusting your thinking for the point that someone who wants to own their own business can go to bat more than once.

Metalcat

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Re: Does self-employment on average deliver a higher income?
« Reply #11 on: January 19, 2023, 08:50:55 AM »
I think you need to quantify the effect of your first three points. And then also to be fair quantify the effect of those same issues for, say, people who want to go to medical school and become a doctor. Or people who want to get a Ph.D. and become a college professor.

All that said, we obviously interpret the data and our experiences differently. And a good discussion only helps others following this discussion make better choices. So truly appreciate your comments and perspective.

P.S. I don't know if you've ever seen or read Scott Shane's book, Illusions of Entrepreneurs. But it makes arguments similar to those you're making. Here's my rebuttal to Professor Shane's points. Illusions of Entrepreneurship Professors.

P.P.S. I think you ought to consider adjusting your thinking for the point that someone who wants to own their own business can go to bat more than once.

I don't really want to argue this any further, I don't have the energy and I'm on heavy drugs. So I'll just back away.

SeattleCPA

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Re: Does self-employment on average deliver a higher income?
« Reply #12 on: January 20, 2023, 10:24:02 AM »
I think you need to quantify the effect of your first three points. And then also to be fair quantify the effect of those same issues for, say, people who want to go to medical school and become a doctor. Or people who want to get a Ph.D. and become a college professor.

All that said, we obviously interpret the data and our experiences differently. And a good discussion only helps others following this discussion make better choices. So truly appreciate your comments and perspective.

P.S. I don't know if you've ever seen or read Scott Shane's book, Illusions of Entrepreneurs. But it makes arguments similar to those you're making. Here's my rebuttal to Professor Shane's points. Illusions of Entrepreneurship Professors.

P.P.S. I think you ought to consider adjusting your thinking for the point that someone who wants to own their own business can go to bat more than once.

I don't really want to argue this any further, I don't have the energy and I'm on heavy drugs. So I'll just back away.

Hey, sorry. Wasn't trying to be argumentative. Appreciate your comments and interest. Hope you feel better soon.

Metalcat

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Re: Does self-employment on average deliver a higher income?
« Reply #13 on: January 20, 2023, 10:31:23 AM »
Hey, sorry. Wasn't trying to be argumentative. Appreciate your comments and interest. Hope you feel better soon.

No need to apologize. I'm just heavily medicated at the moment and you made a lot of comments that I would need to actually formulate a fairly involved response to.

I can write just fine right now, but only the thoughts that come into my head, I can't *make* thoughts make sense at will right now.

Suffice to say, my points are not absolutes, they were about trend averages in aggregate data.

Were I cognitively here, I would have a lot of comments in response, but my brain is a bit mushy.

Smokystache

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Re: Does self-employment on average deliver a higher income?
« Reply #14 on: January 20, 2023, 12:28:02 PM »
SeattleCPA - I always appreciate your posts and additional links/sources.

I definitely think there are quite a few people who are self-employed (in this case, defined as trying to make money and don't receive a W-2) who limp along for years making very little or less than the average W-2 employee. These may be everything from restaurant/food truck owners, caterers, MLM adherents, consultants, life coaches, etc. While some businesses follow the "quick to fail" model (including my assumptions about anyone starting a restaurant), there seem to be a significant number who limp along - making enough to not go back to a w-2 job, but not exactly failing either.

I definitely think the swings are higher. I've quit a W-2 job as a professor, made less for a while, and now make significantly more. I hope I'm getting better at this, but I also know the swings are a real possibility.

Thanks for the info.

SeattleCPA

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Re: Does self-employment on average deliver a higher income?
« Reply #15 on: January 20, 2023, 04:52:43 PM »
SeattleCPA - I always appreciate your posts and additional links/sources.

I definitely think there are quite a few people who are self-employed (in this case, defined as trying to make money and don't receive a W-2) who limp along for years making very little or less than the average W-2 employee. These may be everything from restaurant/food truck owners, caterers, MLM adherents, consultants, life coaches, etc. While some businesses follow the "quick to fail" model (including my assumptions about anyone starting a restaurant), there seem to be a significant number who limp along - making enough to not go back to a w-2 job, but not exactly failing either.

I definitely think the swings are higher. I've quit a W-2 job as a professor, made less for a while, and now make significantly more. I hope I'm getting better at this, but I also know the swings are a real possibility.

Thanks for the info.

Thanks @Smokystache . I do think in mature industries, trades and business categories, it takes a while to get good enough to "play well. " Let's keep this amongst ourselves. But gosh I think it took me a decade to figure out how to run a CPA firm correctly.

BTW if you haven't looked at this, that "Capitalists in the Twenty-First Century" research paper, while extremely dense, is illuminating. And inspiring.

Also? Hey I'm gonna admit it. I like the "Millionaire Next Door." I think Thomas Stanley was onto something.

GilesMM

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Re: Does self-employment on average deliver a higher income?
« Reply #16 on: January 20, 2023, 06:59:04 PM »
Lots of doctors, lawyers, CPAs and all business owners are self-employed so it can be very lucrative.  And these days skilled tradesman who are self-employed are raking it in - electricians, plumbers, etc.  The average worker at a big company like Amazon or General Motors, not so much.

Lamancha

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Re: Does self-employment on average deliver a higher income?
« Reply #17 on: January 20, 2023, 10:15:26 PM »
One nice thing about being self-employed is the fact that you can often work as much or as little as you want.  I'm willing to bet that a lot of self-employed people could make more money if they wanted to.  If you own something like a service business with no brick and mortar location, you can literally work whatever hours that you want.  I've owned several businesses over the years and some months I would work a ton of hours to make a lot of money, and some months I would take 3 weeks off to go camping in the woods.

The supposed failure rate of new businesses seems overly high in my opinion.  The Bureau of Labor and Statistics says somewhere around 50% will fail within 5 years, but what is their definition of failure?  Every business that I have ever owned (except the one I own now) is no longer in business.  Does that mean they failed?  They were all successful.  They all made good money, and I had a blast owning them.  After several years I would move on to other interests though, usually starting another business, but sometimes getting a W2 job.  They were all one-man sole prop shows that were not worth the hassle of trying to sell, so I would just let the business licenses expire and move on to the next thing.

On paper, and in these statistics they would all fall into the 50% failure rate.  I think that is sad because it probably scares a lot of would-be entrepreneurs from every taking the leap.

SeattleCPA

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Re: Does self-employment on average deliver a higher income?
« Reply #18 on: January 23, 2023, 07:05:18 AM »
Lots of doctors, lawyers, CPAs and all business owners are self-employed so it can be very lucrative.  And these days skilled tradesman who are self-employed are raking it in - electricians, plumbers, etc.  The average worker at a big company like Amazon or General Motors, not so much.

Agreed. But I think it's even more pronounced that you describe above.

Sorry to keep promoting that "Capitalists in the Twenty-first Century" paper but what that paper says is the doctors, lawyers, contractors, dentists, CPAs, auto dealers, restauranteurs, etc are the folks getting rich if they own their own business or a piece of a business. Not the founders or executives at Amazon.

GilesMM

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Re: Does self-employment on average deliver a higher income?
« Reply #19 on: January 23, 2023, 07:54:05 AM »
Lots of doctors, lawyers, CPAs and all business owners are self-employed so it can be very lucrative.  And these days skilled tradesman who are self-employed are raking it in - electricians, plumbers, etc.  The average worker at a big company like Amazon or General Motors, not so much.

Agreed. But I think it's even more pronounced that you describe above.

Sorry to keep promoting that "Capitalists in the Twenty-first Century" paper but what that paper says is the doctors, lawyers, contractors, dentists, CPAs, auto dealers, restauranteurs, etc are the folks getting rich if they own their own business or a piece of a business. Not the founders or executives at Amazon.


Not sure about restauranteurs - most have struggled the last few years.  Also not sure Amazon founders are not rich, sure seems like they are.

But, generally speaking, those who "specify" (e.g. engineers) will never have the earning potential of those who "sell".  There are limits to how much you can earn when someone else controls your salary.

SeattleCPA

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Re: Does self-employment on average deliver a higher income?
« Reply #20 on: January 23, 2023, 05:03:41 PM »
Lots of doctors, lawyers, CPAs and all business owners are self-employed so it can be very lucrative.  And these days skilled tradesman who are self-employed are raking it in - electricians, plumbers, etc.  The average worker at a big company like Amazon or General Motors, not so much.

Agreed. But I think it's even more pronounced that you describe above.

Sorry to keep promoting that "Capitalists in the Twenty-first Century" paper but what that paper says is the doctors, lawyers, contractors, dentists, CPAs, auto dealers, restauranteurs, etc are the folks getting rich if they own their own business or a piece of a business. Not the founders or executives at Amazon.


Not sure about restauranteurs - most have struggled the last few years.  Also not sure Amazon founders are not rich, sure seems like they are.

But, generally speaking, those who "specify" (e.g. engineers) will never have the earning potential of those who "sell".  There are limits to how much you can earn when someone else controls your salary.

I'm sure you're right about many restauranteurs getting beat up in the pandemic due to lockdowns and then consumer behavior changes. What the "Capitalist" paper pointed out though was successful restaurant owners in their study ended up really well.

And then to clarify something. Their paper rebuts the work of French economists Thomas Piketty, Emmanuel Saez and Gabriel Zucman who have said the big C corps and their founders have made all the money. And what Rogoff and his co-researchers pointed out is that the doctors and lawyers, dentists and contractors, etc, as a group earn more income and hold I think more wealth. (But that's tricky.)

Here's a relevant quote from page 2 of their paper:

Quote
Overall, we find that top earners are predominantly human-capital rich rather than financial-capital rich, and that 53% of top 1% income accrues to the human capital of these wage earners and entrepreneurs.