Solving the income inequality puzzle

Taking income from those who have earned it and giving to those who haven’t won’t solve the inequality problem. Here's what will. Photo: AP

WASHINGTON, December 6, 2013 — President Obama said this week that income inequality is the “defining issue of our time.” He further said that the decline in economic mobility of the lower classes is a direct consequence of inequality, and that the lack of opportunity is out of sync with the country’s founding values. He said inequality poses a “fundamental threat” to “our very way of life.”

Nobel Prize winning economist Joseph Stiglitz says that the problem is so bad that if we do not act quickly, we risk becoming “two societies living side by side, but hardly knowing each other.” He says action is needed immediately.

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And they are right.

The president’s solution is to raise the income tax, the capital gains tax, the dividend tax, the Medicare tax and other taxes on those who have made the largest contributions, and give that money to the bottom 15 percent who, for whatever reason, have not earned enough to support themselves. By taking from the top and giving to the bottom, the president believes he can reduce income inequality. The reality is exactly the opposite.

Income inequality has significantly worsened in the past five years. Because of astronomically high rates of growth in the money supply, coupled with the Federal Reserve’s policy of buying $85 billion worth of government bonds and mortgage-backed securities every month, the stock market and other financial markets have soared. This has yielded huge increases in wealth to upper income earners.

At the same time, the president’s programs have discouraged the bottom 15 percent from earning income. He essentially gives them a free ride by providing years of unemployment benefits, virtually free health care, and liberal welfare and food stamp benefits. The result has been the classic “the rich got richer and the poor got poorer.”

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So how do we solve the puzzle? First let’s understand the problem.

Bob and Ed are hungry and don’t know how to get food. Jane has been fishing all day and has 10 fish. This represents a very unequal distribution of wealth. The president’s solution would be to take 6 fish from Jane and give three each to Bob and Ed. The distribution is more equal for now, but there are two long-term problems.

First, Bob and Ed have been made dependent on Jane for food. Second, Jane must catch enough food each day to feed herself and two others. In the long-run, this will not work.

We could teach Bob and Ed how to fish and help them get the fishing equipment so they can catch their own food. This eliminates both long-term problems, because Bob and Ed are self-sufficient and instead of taking from the system, they contribute to it. The feeling of belonging and self-esteem vastly improves their quality of life.

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Jane has been relieved of the burden of having to support herself and the two others. Now whatever she earns is hers. She, too, feels more satisfied. As Bob and Ed gain experience and knowledge about fishing, they start to catch fish. The income gap narrowes and there are no long term problems.

The way to reduce income inequality is not by having the government act as an extremely inefficient agent to transfer income away from those who have earned it and toward those who have not, but rather to provide the opportunity, the means and the incentives for everyone, particularly for those in the bottom 15 percent, to contribute.

The private sector provides the majority of the jobs. These jobs represent opportunity for the unemployed, the underemployed and those at the low income levels. Government policy should be geared toward high growth rates in the private sector. We need for the private sector economy to grow at 4 percent, 5 percent or more. Our current policy does just the opposite, and the private sector struggles to grow at a rate of 2 or 3 percent per year.

Increased government regulations are slowing growth. Increased costs to business for health care are slowing growth. Proposed increases in the minimum wage will slow growth. Raising taxes on anyone, particularly the wealthy who provide the investment capital, will slow growth. Large government deficits designed to stimulate growth haven’t worked in the short term and may reduce growth in the long term, if the public debt creates a capital shortfall for business.

Income inequality will not be reduced by taking income away from those who have earned it and giving it to those who haven’t. It will be reduced when more Americans become self-reliant and when those in the lowest income brackets increase their income by contributing more to the economy. For those of us who started near the bottom and were able to move up, that’s the way we had to do it.

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Michael Busler

Michael Busler, Ph.D. is a public policy analyst and an Associate professor at Richard Stockton College teaching Finance, Financial Institutions, Introduction to Financial Management, Game Theory, Graduate Managerial Economics, Graduate Financial Management. 


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