Elgin Hushbeck – Income Inequality (Question 4)

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Link to question #4, including the videos referenced in responses.

What, if anything, do you think should be done about income inequality in the United States?

There were a number of issues with the Wealth Inequality in American video and it raises a number of questions.  First off, there were a couple of issues with the video itself.   Probably the biggest is how it tended to blur the concepts of wealth and income.  While related, these are not at all the same thing.  Wealth is how much a person has.  Income is how much a person earns in a given year.   This is an important distinction for two reasons.

The first is that income stats routinely ignore public assistance, and thus make the poor seem worse off than they actually are.   To see this, consider the following thought experiment.   Person A earns just $1000 over a year from odd jobs here and there while person B has a job that pays $20,000 per year.  This would make it seem as if Person B’s income is 20x what person A gets.   But let say that person A get housing, food stamps and other forms of assistance that amount to a total of $15 thousand.  Does 20 times the income remain a fair characterization?

The other issue emerges when we start thinking about solutions. The video ends by saying that “all we need to do is wake up and realize the reality in this country is not at all what we think it is.”  Really?  And what happens when we all wake up?  I will return to the question of solutions later, but currently all the proposed solutions deal with increasing the income tax “on the rich.”  But income and wealth are not the same thing.

Again consider an example of two people. This time person A works very hard with a lot of overtime and as a result earns $100,000 in a given year.   Person B does not work at all, but lives off an inheritance, which is invested such that they earn $100,000 per year.   Are these people really equally rich?  In terms of income tax they are. In fact person B may even seem “poorer” to the IRS because much of their income might be from tax free municipal bonds.

There are some other issues with the video.  For example, it does not take into account the age distribution within the population.   It is just a fact that most people tend to accumulate wealth over their life time and some of those at the top end, were at the other end earlier in their life.   So some inequality is unavoidable unless people are forced to remain poor over their lifetime.

Then there were the comments about the top guy’s “stack of money” and that he had “so much green in his pocket.”  But in reality little wealth is in terms of money.  It is not sitting in someone’s pockets or stacked away in some bank vault.  It is invested back into the economy in term of wide range of investments from venture capital to launch new businesses to funding expansions of existing business; it is in factories, office buildings and malls.  In short it is put to work in investments that drive much of the economic growth.  So it is no surprise that those who are the best at growing the economy end up being very wealthy.

There are some other issues and perhaps they will come up in the follow-on discussion, but let me return to the issue of solutions.  Again the video implied that all we need do is wake up, as if there were a single clear solution that automatically presented itself.  But that is hardly the case.

In fact I believe that past attempts to address this issue have only made things worse.  A big push to address this issue in the 1990s resulted in linking executive pay to performance.  It sounded good at the time but the result was stock options that have only made income inequality even worse.

Increasing income taxes is also a counterproductive solution as they are much more effective at keeping people from becoming wealthy than in reducing wealth inequality.  Again this is because they go after income not wealth.   We could, of course, place a tax on wealth itself, but Democrats have a large constituency in the truly wealthy and are unlikely to propose such a tax.  Republicans are unlikely to support such a tax because, while it would redistribute wealth, it would hurt the economy even more.

Then there is the question of should we address this issue at all. To some extent I think we should.  I do think it is questionable that the upper management gets paid so much more than average workers.  But the key issue is how to address it.  As I mentioned earlier, one of the things that has exacerbated the current inequality is previous attempts to address it.  To be successful, any solution will have to be a solution that works within the market, not against it.

Thus we come to the key question, which is more important:  that people’s lives are better, or that they are equal?  The video assumes that equal is better, but that brings us to one of the biggest problems with this analysis, for it assumes a fixed amount of wealth.  This can be seen in statements such as the poor are “starting to suffer quite a lot” and “the middle class are struggling more than they were.”  Such statements assume that as the wealthiest get more, the poor and middle class have less.  This certainly can happen, but in a healthy free enterprise system people become wealthy by growing the economy and that benefits all.

So first and foremost I believe we need a strong, vibrant, and growing economy and this means we need an economy where there is real choice and competition, an economy so strong that employers must complete for workers for such an environment will drive up wages and improves working conditions. An economy where workers have both the freedom and the options to changes jobs if they don’t like their current employer, or more importantly the chance to create their own business if they want to.  True, this will lead to inequality.  But I am more interested in people doing better than being equal.