Democrats and socialists claim that greedy capitalists are unfeeling and mostly responsible for the dramatic differences between the ‘haves’ and the ‘have-nots’ in our society. While Conservative Republicans claim that government entitlements demotivate people to do better for themselves. There is some truth in both statements. However, by understanding a larger truth, we will be able to better solve income inequality and prosperity for all.
What are the income inequality facts?
The chart below shows how the income gap has grown from 1947 up to 2013. Income rose almost the same for low earners and higher earners alike until 1973. In the late 1970’s, the income gap grew, until it has reached a dramatic difference in 2013.
What is causing the income gap?
Several causes to this income disparity have been blamed, including: trickle down economics, entitlement traps, capital vs labor taxation, fiat currency, and free trade:
When Ronald Reagan was elected in 1980, he worked with congress to reduce the highest marginal tax rates believing that this tax break would stimulate more investment and therefore produce economic benefit for all U.S. citizens. Political pundits have termed this tactic as ‘Trickle-Down Economics’ or ‘Supply Side Economics’. Critics of this strategy say that this move has led to the wide disparity of income we see today. In other words, tax breaks given to high income earners has resulted in enriching wealthy and has not resulted in job-creating investments for the working class.
When you pair the chart above showing the decline in top ordinary income and capital gains tax rates, you can make the case that reductions in taxes have disproportionately benefited the wealthy; with no corresponding ‘trickle down’ to lower income earners.
Often called a ‘Welfare Trap’, people get in a situation where finding employment or making any improvements in their income will result in a net loss when loss of government paid entitlements are taken away. If you consider all of the entitlement benefits available to citizens today, a single breadwinner for a typical family of four in the United States who earns less than $20,000 per year cannot receive additional income until they make over $60,000 per year. The math on these benefits changes based on the details, but you get the picture.
When you contrast this idea with the actual household income distribution on the chart above, you can see how most income earners are bunched up below the median income of $50,000 (2011 Data) lending credence to the notion that there is an ‘entitlement trap’.
If a wealthy person owns land, or corporate stocks, or treasury bonds, they make money with the use of money they already own. If a person is wealthy enough, he or she can sit at home and simply allow their money to work for them. Middle class and poor people have very little in savings as the money they earn is used immediately for living expenses. To make matters worse, the government taxes labor earnings higher than capital gains earnings typically garnered by wealthy individuals.
If you review the capital gains vs ordinary income tax chart above, there is a clear correlation between drops in capital gains taxes and the increase of income of top income earners.
Fiat currency is the use of paper; or in our modern day electronic data as a currency. Throughout most of history, gold or silver was used as currency. In 1913, the U.S. created the Federal Reserve which was intended to be the lender of last resort. This meant that they would lend money to banks who were short of depositor’s cash if people wanted to suddenly pull their money out of the banks. Even after the creation of the Federal Reserve, the U.S. was still on the gold standard. This meant that their currency had to be backed with actual gold. In 1933, President Franklin D. Roosevelt took the U.S. off of the gold standard and replaced it with a pseudo gold standard. In 1972, President Nixon took the U.S. off of this pseudo gold standard for good. This meant that U.S. money is not back by anything of value; and is a complete fiat currency. The government can create money for any reason it wants. In this fiat currency system, the government creates money by spending it.
At first glance, this seems like a magical system. The government can create as much money as it wants. This means that we should be financial secure for the rest of our nation’s existence. Unfortunately, it’s not quite that simple. If too much money is created, it can cause inflation. When a lot of money is in circulation, and a limited amount of goods are available to purchase, the price of those goods will increase.
So what does fiat currency have to do with income inequality? The fiat currency that is created by our government is actually debt. This debt is owned by a variety of entities including, social security, foreign governments, and investors with surplus savings. So, while the government is creating all of this money and debt; investors are earning interest; while the average consumer is paying more for goods and services.
If you revisit our income gap chart trend from 1998 to 2013, you’ll notice that the income for the wealthiest Americans stayed flat, while income for the lowest income earners dropped slightly. During this period, government debt grew dramatically from roughly $5.2 Trillion to $18.5 Trillion today. While this growth in debt would normally be a windfall for wealthy investors, because the Federal Reserve kept interest rates low, even wealthy investors could not gain much in this investment environment.
Critics of this theory will say that inflation has not been that high during this period of fiat currency with the exception of the late 1970’s. The fact is that government debt and deficits create private sector surpluses. And, I guarantee you that these surpluses are not owned by the middle and lower class; they are owned by the bankers and wealthy private investors.
Many unions have complained that free trade agreements tend to ship high-paying jobs out of the U.S., while U.S. companies claim they need the use of cheaper foreign labor to compete in the global marketplace. The chart below shows the effect of the Canadian and Mexican free trade agreements collectively known as the North American Free Trade Agreement (NAFTA) completed in 1994.
These agreements have clearly created a trade deficit with these two countries and have resulted in the loss of high-paying manufacture jobs in the U.S. Very recently, the U.S. congress and President Obama approved the Trans-Pacific Partnership (TPP) agreement. I would anticipate that our trade deficit will grow substantially with passage of this bill further eroding what manufacturing jobs we have remaining in our economy.
There is no question that such agreements have contributed to the income gap we see in the U.S. today.
Is Income Inequality a Problem?
For most of my life, I have not paid attention to the ‘income inequality’ problem. I felt like I earned sufficient income by working hard, gaining knowledge and experience and making the right business decisions. The idea that everyone should earn the same amount of money regardless of their effort has always struck me as Un-American and Un-Fair. After all, we live in the land of opportunity. If you fail to take advantage of that opportunity, it’s no one’s fault except your own.
As hard as I have worked to achieve my personal level of success; I feel like I was quite blessed in many of my endeavors as a result of being in the right place at the right time. It’s sometimes difficult to separate my work effort from good fortune. Just like it may be difficult for someone to separate their work effort from bad fortune. Still, it’s like the old adage coined by Lee Trevino, “the more I practice, the luckier I get.” Most people have succeeded with hard work and intellect in combination with the circumstances they’ve faced.
I could pontificate forever on this topic; but need to settle on an answer to the question, “Is income inequality a problem?” To the extent that government is creating a fair environment for any individual to create wealth for themselves, there really is no problem. However, as we have noted, in an attempt to help, our government has further widened the income gap.
What has been tried so far? Is it working?
Many critics of wealth redistribution tactics by the government have rightly claimed that government programs thus far have done nothing to address poverty. In other words, the War on Poverty is failing miserably. We have tried several wealth redistribution schemes, debt producing stimulus projects, and raising the minimum wage. Why have none of these efforts worked? Instead of helping the low and middle class, they have pushed more high-paying jobs overseas, increased the roles of the unemployed and underemployed, and created more national debt.
Where do 2016 Presidential Candidates Stand?
Bernie Sanders has been, by far, the most vocal presidential candidate on income inequality issues. He wants to: 1) increase taxes on corporations; 2) increase estate taxes for estates over $3.5 Million; 3) increase taxes on wall street speculators (short term capital gains); 4) increase the minimum wage; 5) increase debt by $1 Trillion to invest in infrastructure; 6) subsidizing an additional $5.5 Billion to employ young people; 7) free tuition at public schools; 8) increasing social security taxes for high-income earners; 9) single-payer healthcare system; 10) increase mandatory family leave benefits from employers; 11) legislate improved worker union strength; and 12) break up current banking monopolies.
While most of Senator Sanders’s ideas seem beneficial, they will all increase debt, decrease our liberty and increase unemployment. The six items in Senator Sanders’ plan I believe will not work and why:
1) Increased taxes on multinational corporations will drive U.S. companies further out of our country to pursue business in more business friendly countries.
4) Increasing the minimum wage will further reduce the young people he advocates he wants to employ with his $5.5 Billion program; and may drive up unemployment and force employers to automate.
7) With our current college system, 40% of college graduates are unemployed or underemployed. With these statistics, free education will do nothing to improve the situation.
8) Increasing social security taxes will only add more funds to a failed forced-savings program. While I agree with taxing higher income earners more, it would come in the form of a fair progressive income tax, not expanding social security.
10) Increasing mandatory benefits for employees will have the same negative ramifications of driving U.S. companies out of the country. If companies stay, their product prices will have to increase to compensate for the better benefits which will cause inflation leading to higher income disparity, not lower.
11) Increasing union strength will not necessarily increase compensation of workers. Strong unions have prompted U.S. companies to look for more affordable labor elsewhere. Why do we think this will be any better if we strengthen unions now?
Jeb Bush’s idea on closing the income gap is simply doubling-down on Trickle-Down economics. He has advocated decreasing all income tax rates, increasing earned-income tax credits and somehow still growing the economy by 4% per year. Objective analysts of Jeb Bush’s tax plan have indicated that he will increase our nation’s debt between $1 Trillion and $4 Trillion with his plan. In my opinion, Jeb Bush has all of the wrong ideas. He is expanding the entitlement trap, while reducing tax revenues.
Hillary Clinton’s plans to close the income inequality gap include many of the elements that are stated more specifically and concisely by Bernie Sanders. Most of Hillary’s plans will further complicate our tax code in an effort to try to make companies treat their employees better. Of the two plans, Bernie Sanders’ plan is easier to understand and is more specific. Hillary’s plan seems over-complicated. And her plan will likely backfire in the same ways as Senator Sanders’ plan.
Marco Rubio probably comes the closest to my personal philosophy than any 2016 presidential candidate thus far. He advocates a smaller size of government, reducing national debt and simplifying taxes. However, he fails to reference elimination of free-trade agreements in his proposed actions to reduce income inequality.
Donald Trump has been somewhat vague on how he plans to close the income gap. He has advocated that he would tax the rich more… which contradicts his previously proposed tax plan limiting the top rate to 25% (now 39.6%). I personally do not believe you can put any stock in claims Trump makes about income inequality until he becomes more specific.
Chris Christie has many of the traditional elements shared by other republican candidates. He has described how federal debt has increased government cost for all tax-payers. He has also advocated lowering taxes and expanding entitlements. He has been the leader in putting forth a plan to save social security by eliminating benefits for wealthy citizens, gradually increasing the retirement age and possibly reducing benefits. In my opinion, most of these efforts will not do much at all to close the income gap.
So what should we do about income disparity?
There are six things that can be done to reverse the income gap problem:
- End free trade agreements. A domestic U.S. manufacturer is faced with costs and hassle that make it desirable to locate their manufacturing facilities in foreign countries. There is no way to combat the low wage attraction of foreign countries, but we can at least tax imports sufficiently to balance the scales; and ensure domestic regulations are not onerous.
- Fair, progressive income tax. A tax rate should be levied that taxes all capital gains and labor income the same. I propose a flat rate of 20% up to $100,000 per year; then a graduating rate increasing to 40% per year for incomes of $500,000 per year.
- Corporate tax break. I would drop the corporate tax rate to 10% and base this tax on an average income over a three year period.
- Limit entitlements. Gradually reduced safety-net programs to eliminate the current entitlement trap.
- Reign in Government Debt. I advocate a gradual reduction in deficits and debt to reduce government interest costs and inflationary pressures.
- Currency Discipline. I would link our currency supply, federal funds rate and government debt levels to a more disciplined system of control. I would end basing the system on our current unemployment levels.
I have made several bold assertions in this blog post and would love to hear your ideas on ending income inequality. Please let me know what you think in the comment section below.