Income Inequality: Is More Government the Solution or Part of the Problem?

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While other issues, such as gun control, direct the media’s attention right now, the movement against income inequality is one that never lies dormant for long. For some, any improvement in the economy as a whole without an immediate and corresponding gain in their personal situation is a bad thing. It’s another sign of how the “1%” is doing ever better at everyone else’s expense.

As an example, a recent essay by Warren Buffett for Time on the bright future of American commerce has been used to highlight the growing disparity in income between the “haves” and the rest of us.

In reading that article, it’s easy to see how income inequality has become such a crusade for the left. Buffett shares a factoid that stings these equality crusaders: from 1982 to the present, the average net worth of the 400 wealthiest people in America has grown 29-fold. Meanwhile, that of the poorest families has barely budged. This statistic, and many others just like it, are viewed by the left as resounding indications of how extensively our current economic system is failing Americans as a whole.

The system isn’t fair, and something needs to be done, they argue, and, as so often happens when the left sees something to be done, they propose government action as the solution. Unfortunately, there are two issues with this line of thinking.

First, the focus on inequality misses (or, perhaps more accurately, ignores) the fact that while the gap between those with the most wealth and those with the least is increasing in relative terms, when we look at real income, by absolute standards everyone is doing better over the same time periods.

The rich may be outpacing the lower-class in income growth, but the lower-class of today is not only earning more (in real terms) than the lower-class of previous generations by almost all absolute measures, they’re also doing better than the middle- and upper-classes of many previous generations. According to this CBPP study on income inequality, the 20th percentile of income earners today earns nearly as much in real terms as the 95th percentile in 1980. The gap between the lowest earners and the highest certainly has increased since the 1980s, but that fact alone doesn’t reflect the importance of the absolute gains all earners have seen.

Those in the lowest economic tiers have not seen their level of wealth increase to the same extent as those in the highest tiers because the former are spending a much higher portion of their incomes improving their day-to-day lives, whereas the highest level of earners are accumulating more of their increased earnings leading to those increasing net worth levels cited by Buffett and others.

This likely has to do with the fact that earning beyond a certain level doesn’t tend to increase happiness. As the lower- and middle-classes earn more, they spend more to enjoy life more. The rich are already spending beyond this threshold and consequently are more likely to invest their growing income (leading to more wealth) as increasing their spending doesn’t make their lives that much better. Is that really all that bad? Would you prefer the wealthy spent their money frivolously instead of reinvesting into businesses that create jobs and make people’s live easier?

Focusing exclusively on the gap between the “rich” and “the rest of us” ignores the very real gains that everyone has have made over the past 20-plus years. A recent 76-page report by the anti-poverty organization Oxfam pours over page after page of statistics deploring the devastation income inequality causes. But they also admit that “between 1990 and 2010, the number of people living in extreme poverty (i.e. on less than $1.90 a day) halved, and has continued to decline since then.”

Let’s ignore for the moment the absolute gains that have been made by all under our current system and, for the sake of argument, agree with the left that income inequality is an issue that needs to be addressed. Even so, the currently proposed solutions relying on government intervention in the form of new laws, taxes and regulations is going about things in entirely the wrong way.

Let’s take a look at what typically happens when government attempts to “fix” things. This NY Times article by Jonathan Rothwell is a must read for thinking more government is the solution to economic inequality.

Rothwell summarizes research showing that the gap between the wealthiest and the rest is increasing in the US, just as the left argues. Digging deeper, however, he exposes a truth that runs counter to the narrative that “unregulated capitalism run amuck” is the cause of that disparity.

Most income growth, and much of the widening income gap, in recent years has come from just three sectors – professional services, finance and insurance, and healthcare.  What do these three industries have in common? They’re three of the most highly regulated industries in our country. These high levels of regulation serve as significant barriers to entry into those fields, leading to lower competition, and outsized success – and income – for those at the top.

Ignoring these three industries, the US’s wealth gap looks much like our more social-equality minded neighbor to the north: Canada.

The more rules there are, the harder it becomes for smaller firms – with limited resources and staff – to keep up.

Even the admittedly anti-income inequality authors of the Oxfam report mentioned above, (indirectly) admit that government is a part of the problem, stating “There is growing evidence that the current levels of extreme inequality far exceed what can be justified by talent, effort and risk-taking. Instead they are more often the product of inheritance, monopoly or crony connections to government.” In fact, their research shows that nearly one-third of billionaire wealth is due to monopolies and cronyism. Government regulations are needed to protect monopoly power, and cronyism also depends on government protection of their interests in the way of laws and regulations.

If the growing income inequality is truly a crisis that needs to be addressed – and it’s not at all clear that it is, since, in absolute terms, all are better off now than before, and we are currently doing more than ever before to wipe out poverty – then government intervention is not the solution. Instead, we should be evening the playing field by getting government out of the way as much as possible to make it easier for people to start new companies and successfully compete, leading to more jobs, more income and more wealth for all instead of trying to use government to “bring down the rich.”

* Mark Durrenberger, CFP®, EA, is a financial planner and author of The Modern Day Millionaire. He writes regularly on economic events, personal finance and investing at www.markdurrenberger.com and believes embracing personal responsibility will do more to improve financial wellness than all the government programs in the world.

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