Saturday, August 21, 2010

Why Is Income Disparity Widening?

That income disparity is increasing is not in doubt, but the causes--and thus the solutions--are not easily parsed.

The statistics are unequivocal: The Gap Between the Top 5% and the Bottom 95% Is Widening in America. Is this the result of "natural" forces, or of government favoritism?

In a nutshell, the potential causes of the widening gap can be divided into two camps: "natural forces" of capitalism and Central State intervention.

Causal factors in the first camp include:

-- The differences in education, motivation and skills in people; the hardest working, most ambitious and most highly skilled people will naturally end up making more money than those with less skills and drive.

-- The differences in humans' propensity to save/invest or consume/gamble. The Pareto Principle suggests that 80% of the property and wealth ends up in 20% of the populace's hands, regardless of the initial state (in other words, even if income is evenly distributed to start with).

-- The globalization of trade and manufacture has introduced an extremely competitive wage arbitrage in which American workers are often competing with workers not just in different states but in different countries.

In general, this camp is discounted by "progressives" to whom innate differences between people are verboten for ideological reasons; the "liberal" ideology often confuses equal rights and opportunities with equal ability and drive.

The "progressive" agenda is thus set on equalizing not just rights and opportunities but skillsets, education, etc.--everything which is perceived to be a sociological wellspring of unequal skills and motivation, and thus of future income. Government intervention is thus essential to keep the society from diverging into financial nobility and serfs.

The "conservative" ideology discounts these sociological factors--education opportunities, marital state of the family, living conditions, etc., on the grounds that immigrants to the U.S. often arrive with little money, skills or education, yet many prosper quickly despite these (for U.S.-born citizens) supposedly insurmountable handicaps.

The "conservative" ideology is more accepting of what is often (mistakenly) called the Darwinian characteristics of capitalism; those with less motivation and fewer valuable skills must either try harder or be left in the wake of the economy.

(Darwin's work described the forces of natural selection between and within species, not between individuals in a community. Thus the struggle between "species-like systems" such as U.S.-style capitalism and Soviet-style Communism could be rightly viewed as Darwinian, as the competition, mutation/adaptation and selection process was systemic rather than individual.)

The "conservative" ideology objects to the government's role in attempting to correct sociological inequalities by redistributing income on the grounds that those who work the hardest are being penalized while those who make less effort are in effect rewarded.

I reside in neither camp, though I am sympathetic to various arguments on both sides.

I have observed that no sociological incentive can motivate a human being; they must find their own path to motivation. Giving people endless free stuff merely makes them dependent and atrophies their self-reliance and ability to work with others. Whatever is given as "free" is rarely valued, education being the most obvious example.

I live in a high-immigration state (California) and thus I have personally witnessed immigrants arrive with nothing, work two jobs, save every penny they can from their earnings, and buy houses, cars and businesses for cash a few years later. The only U.S.-born citizen I know who achieved the equivalent is my wife, who worked and saved enough in five years of ceaseless toil at low-wage jobs to buy her mom a house and pay off the entire mortgage. My wife completed this goal when she was 23 years old, and then she finished college. I am sure there are many such U.S.-born people, but I don't know any.

One of the dirty little secrets in America is that excuses are offered in endless millions here; my wife was raised in a single-parent family and her Mom worked at low-level jobs her entire life. Many Americans will devote more energy to creating excuses than they will to changing their life circumstances, and they often resent anyone from humble backgrounds who has accomplished a positive life change. (This is called "the crabpot syndrome" to those in the know.)

In our politically correct society, these observations are verboten, and quickly marginalized or dismissed.

I have also observed that many people I know make large sums of money yet they are continually "broke" and own little to no assets. Their consumption ratchets up with their income and their low propensity to save/invest never strengthens.

I suspect long-term cycles of innovation/stagnation, complexity/marginal returns and habituation to a "prosperity" that is no longer sustainable play roles in income disparity, as does globalization.

But if we ask cui bono of the status quo (The starting point of the Survival+ critique), I think we will find the Central State (Savior State) is heavily favoring unearned income over earned income and "gaming the system" financial speculation using other people's money over productive labor. The profits from gamed embezzlement/speculation is private, while the losses are backstopped by the government, i.e. profits are private, losses are public. That doesn't hold true for the 99% who are not financial Power Elites.

Thus I conclude that government/Elite-dominated policy heavily favors the Elites' conservation and accumulation of wealth, and that these factors are systemically (and thus policy) causal factors that we could change if we had the political will. "Fairness" and "hard work" have nothing to do with this set of policies; they are the result of concentrated wealth which buys political favoritism.

Consider the Russian oligarch's $300 million yacht. Did this gent earn his fortune by the sweat of his brow and by generating amazing innovations, or did he merely buy the State's crown-jewel assets for pennies on the dollar in a classic State/Elite sweetheart deal?

A number of readers offered cogent comments on the topic. First up, frequent contributor Michael Goodfellow:

1. Increased opportunity always produces increased inequality. That's simply because the ambitious people will take advantage of the new opportunities and some of them will profit. The more cautious people won't do anything new and won't profit. "If you don't bet, you can't win."

In practice, you have things like real estate booms or tech stock booms, and the people who participate in those (up until the final crash anyway) get very rich. The ordinary types who live paycheck to paycheck obviously don't and can't. But it's also true that those who get the extra education in useful fields are going to benefit from economic growth more than those with high school educations, or useless college degrees.

As the world economy gets larger and more interconnected, there are more and more opportunities, and more and more inequality. For example, Apple (and Steve Jobs) gets rich building iPhones in China. No ordinary worker gets any part of that. But 50 years ago, before globalization, no ordinary American company would have been able to do that either.

There's also this theory that we now have a "winner takes all" economy. This is modeled on the entertainment industry, where a single actor or musical group, not much better than the competition, becomes popular and crowds out all the rest. The winner gets very rich, due to mass media, and the nearly-as-good losers get nothing.

I think the entertainment industry is changing, with more, smaller successes, and the internet will do the same to other kinds of businesses. But you could argue that "winner take all" is what's behind Wal-Mart and the category killers like OfficeDepot. I would argue that it's about efficiency and moving more product with smaller numbers of employees, but you could certainly argue that it's really about name recognition (same as with entertainment), and well-known brands like Amazon and NetFlix just don't leave any room for smaller competitors.

In any case, I don't see this as having anything to do with tax policy or "greed of the elites." These new opportunities are opening because of technology and economic growth. The elites are the ones who take advantage of those opportunities. That's why a Bill Gates can drop out of college and become the richest man in the world. It's not because of quirks in the tax code or friends in high places.

2. There's a limit to how much you can tax the rich. They can restructure their income away from salary to capital gains, or as perks (cars, health care, company apartments, etc.)

Rich people (by definition) also don't have to keep working. These stock brokers and CEOs everyone despises have millions in the bank. If they decided to quit working altogether, they could afford to do that. I assume they work for the fun of it, and the status of having lots of money and toys. If taxes get high enough that they can't get significantly more money, they will stop working. Even if you enjoy your work overall, it doesn't mean you have to do it 80 hours a week.

You could argue that these people are parasites on the financial system, or on government handouts, but if there's anything useful that they do, you'll get less of it as you tax income more. With someone outside the top 1%, like a doctor, this is clearly going to happen. Why work all those hours if your 60th hour a week earns you half of what your first hour does?

3. Rich people already pay for most of the government. What exactly do you want from them?

You already have the top 1% paying 28% of all Federal taxes. The top 10% pay 55% of all taxes and the top 20% pay 69% of the taxes. Their share of taxes has gone steadily up, from 56% in 1979 to 69% in 2006. Meanwhile, the share of the bottom 20% has gone from 2.1% in 1979 to 0.8% in 2006. Share of the bill has dropped for every other quintile as well.

See Taxes paid by quintile, 2009 (CBO).

4. The tax code (and government handouts) are not the problem. I don't know how you'd quantify this, but looking at people like Buffet or Gates, I don't see that things would be any different even if the government left the economy alone.

The ones being bailed out in the latest crisis do include bankers, but they also include millions of people with recent mortgages who don't want to see their house prices drop further. Bailouts for the auto industry primarily benefited unions, not investors (some creditors were just ignored in the bankruptcy.) The health care legislation will temporarily benefit insurance companies by giving them new customers, but in the long run, they are going to be crushed out of existence by government demands to provide more care for less money. The Federal budget is being killed by entitlements, which benefit the poor far more than the rich. State and city budgets are being killed by union pensions and salaries, not giveaways to rich people.

I think increasing income inequality is a result of economic growth, which means it's not something you can get rid of, or would want to get rid of.

Americans are not just divided into rich and poor, they are divided into well-educated ambitious professionals and average Americans with no more education than they had in 1970. That average group is losing the advantage it once had over the rest of the world. Technology has made it easier to do business anywhere, education and infrastructure have improved in other parts of the world, and a billion willing workers have joined the world economy.

None of that is going to change soon, and none of that is due to corruption or crony capitalism or an "unfair" tax code. Telling people that they live in some insiders-only society where they can't win is just encouraging them to give up and get run over.

Aaron S.:

Your article about the "Two Americas" and the growing divide between the top 5% and the bottom 95% is very astute. One thing I have noticed, that you touch upon, is that it has become very easy to fall out of wealth but very difficult to climb into it.

With the outsourcing of productive jobs, the only people that are able to become "wealthy" are those very few who gamble and win. Instead of "working your way to the top," people get wealthy off of other people's investments in startups (which fail, but the CEOs get rich) or by investing in the right asset through sheer luck.

In the meantime, people who are wealthy can lose everything if their investments turn south, which can happen very quickly. Only the few elites at the very top are safe, and they are just sitting back collecting more assets.

Ernesto M:

Though the top 5% of income earners are much better off than those below them (generally), as you state, these are not really elite at all. Most of them by my reckoning are still solidly middle class. If an income of $216,000 is the cut-off, that is only the equivalent of a married couple who each make slightly over $100,000. I suspect that many of these people do not fit the profile of the typical millionaire (which is not even 'rich" anymore and was not then either) included in the 1996 book "The Millionaire Next Door".

A substantial number of them are probably over-indebted consumers who live in high cost cities such as NY, San Francisco and Washington DC because that is where many of the high or higher paying jobs exist. The business owners and secondly some professionals (such as doctors or lawyers) have greater latitude to earn high incomes in more locations.

Despite this, I do not see the tax code as the primary cause for the speculation problem. Its made it worse but the government created moral hazard is a far bigger problem and financial intermediation is also. Even with favorable tax treatment, if the Fed and Treasury did not bail out these losing positions, no amount of tax benefit could induce so many people to engage in the rampant and reckless speculation which permuates the modern financial system.

Thank you, readers, for your thought-provoking observations. There is no one "answer" or "solution" to income disparity, but we should not be hindered from seeking out disparities caused by policies designed to enrich financial and political Elites.

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