This past week the other panelists and I on the Money Mastermind Show covered a topic that I will readily admit I hadn’t really investigated very thoroughly before, the topic of wealth inequality. We decided to focus on the topic of wealth and income inequality after the recent rise and popularity in some circles of French economist Thomas Piketty’s book, Capital in the 21st Century.
In researching for the show I came upon a lot of conflicting opinions of the book, and it seems like people’s opinions of the book’s thesis vary depending on whether you’re a part of the political left or right. Those on the left have been lauding it’s thoroughness and well reasoned use of the data, while those on the right have questioned the data and methods used in his study, and more importantly, the conclusions he comes to.
In the end I think all of us can agree that there is some degree of inequality in incomes and wealth in most societies. The disagreement comes in just how much there actually is, and how much that inequality actually matters. What does it mean for the future?
Here’s our discussion on the topic of wealth inequality, and what people can do for themselves despite not being part of the 1%.
Growing Wealth Inequality
When the topic of wealth inequality comes up, invariably the disagreement comes up as to just how much inequality there really is. In some respects, I really do believe we have growing inequality, and many stats will show you that. Before President Obama’s 2014 State of the Union Address it was reported by some media that the top wealthiest 1% possess 40% of the nation’s wealth; the bottom 80% own 7%.
In regards to this purported inequality, Thomas Piketty stated that,
extremely high levels of wealth inequality are incompatible with the meritocratic values and principles of social justice fundamental to modern democratic societies. The risk of a drift towards oligarchy is real and gives little reason for optimism about where the United States is headed.
Piketty argues that with high wealth inequality, we could expect to see the world’s wealth concentrated with fewer and fewer people, and they would end up having a lot more say in our government and legislative processes than others. We would end up with a wealthy plutocracy that basically rules over everyone else. Piketty proposed a global wealth tax to help alleviate the pressures of wealth inequality.
Just How Much Inequality Is There?
There seems to be some measure of agreement that there is quite a bit of income inequality out there, and there is. The degree of inequality is still up for debate, however.
Many of the standard income measures used in studies surrounding wealth inequality, including Thomas Piketty’s, look simply at tax records of measured pre-tax income. They often don’t count existing wealth transfer programs that over time have become an important part of the standard of living for many folks in the poor and middle and classes. Things like tax cuts, tax credits, health benefits, welfare payments, social security payments, retirement benefits, and so on. Figures from the U.S. Census Bureau and CBO income statistics show:
- In 1980, in-kind benefits and employer and government spending on health insurance accounted for just 6% of the after-tax incomes of households in the middle one-fifth of the distribution.
- By 2010 these in-kind income sources represented 17% of middle class households’ after-tax income
So over the past 30 years in kind employer and government benefits have become a larger part of our incomes, up to 20% in many cases. For those who are poor, it constitutes an even higher percentage of their income, but none of these benefits are ever counted in studies like Thomas Piketty’s. As such they tend to leave out a big chunk of income for many in the poor and middle classes.
Standard Of Living Has Improved For All
Donald J. Boudreaux is a professor of economics at George Mason University, and he argues that while income inequality may have grown, it ignores the fact that over the past 30-40 years the standard of living has improved drastically for just about everyone. People’s access to goods and services has improved.
ultimately, wealth isn’t money or financial assets but, rather, ready access to real goods and services. what people—rich, middle class, and poor—can buy with their money. If we examine people’s ability to consume, we discover that nearly everyone in market economies are growing richer. We also discover that the real economic differences separating the rich from the middle class and the poor are shrinking. Reckoned in standards of living—in ability to consume—capitalism is creating an ever-more-egalitarian society.
Not only have our standard of living gotten better, we’re better able to get access to the goods and services we need than in the past.
Top 1% See Greater Gains In Good Times And Losses In Bad
The top 1% have seen incomes grow quickly in the past few years, more so than those in the middle and poor classes. What often doesn’t get mentioned, however, is that the market incomes of the top 1% are very cyclical. They’ve seen big gains since the recovery, but they were also the ones that saw the biggest wealth drops in the great recession.
The broadest and most accurate measures of household income are published by the CBO. CBO’s newest estimates confirm the long-term trend toward greater inequality, driven mainly by turbo-charged gains in market income at the very top of the distribution. The market incomes of the top 1% are extraordinarily cyclical, however. They soar in economic expansions and plunge in recessions. Income changes since 2007 fit this pattern. What many observers miss, however, is the success of the nation’s tax and transfer systems in protecting low- and middle-income Americans against the full effects of a depressed economy. As a result of these programs, the spendable incomes of poor and middle class families have been better insulated against recession-driven losses than the incomes of Americans in the top 1%. As the CBO statistics demonstrate, incomes in the middle and at the bottom of the distribution have fared better since 2000 than incomes at the very top.
As the quote lays out, the fluctuations of wealth for the top 1% are greater than those in the middle and lower class who are insulated to a degree by government safety nets. So those not in the top 1% may not see as much growth, but they won’t have as much lost either.
Are The Top 1% Really A Permanent Plutocracy?
Another thing that isn’t often mentioned is the fact that the top 1% is not necessarily a permanent plutocracy like many have suggested, but it is actually a very fluid and ever changing group.
Mark R. Rank, a professor at Washington University, and Thomas A. Hirschl of Cornell looked at 44 years of longitudinal data for individuals ages 25 to 60 to see what percentage of the American population would experience different levels of affluence during their lives.
It turns out that 12 percent of the population will find themselves in the top 1 percent of the income distribution for at least one year. What’s more, 39 percent of Americans will spend a year in the top 5 percent of the income distribution, 56 percent will find themselves in the top 10 percent, and a whopping 73 percent will spend a year in the top 20 percent of the income distribution.
Although 12 percent of the population will experience a year in which they find themselves in the top 1 percent of the income distribution, a mere 0.6 percent will do so in 10 consecutive years.
It is clear that the image of a static 1 and 99 percent is largely incorrect. The majority of Americans will experience at least one year of affluence at some point during their working careers. (This is just as true at the bottom of the income distribution scale, where 54 percent of Americans will experience poverty or near poverty at least once between the ages of 25 and 60).
A further example of such fluidity can be found in an analysis by the tax-policy expert Robert Carroll. Using data from the Internal Revenue Service, Mr. Carroll showed that between 1999 and 2007, half of those who earned over $1 million a year did so just once during this period, while only 6 percent reported millionaire status across all nine years.
Data analyzed by the I.R.S. showed similar findings with respect to the top 400 taxpayers between 1992 and 2009. While 73 percent of people who made the list did so once during this period, only 2 percent of them were on the list for 10 or more years. These analyses further demonstrate the sizable amount of turnover and movement within the top levels of the income distribution.
Those in the 1%, as well as in other classes change over time. People will have one or two good years, but then will have bad years as well. People at the bottom move up, and people at the top invariably move down. Wealth has a tendency to get diluted over the years when it is inherited by multiple heirs, and then further by taxes, charity and philanthropy and market changes.
Are Most Of The Wealthy Inheriting Their Money?
One argument you hear is that the wealthy are becoming a permanent plutocracy, handing money down from one generation to the next to their heirs. But just how many of the wealthy actually inherit their money? Not as many as you might think.
Thomas J. Stanley of the Millionaire Next Door explains how a majority of millionaires are self-made, not heirs to a fortune:
Most of America’s millionaires are first-generation rich. Have you always thought that most millionaires are born with silver spoons in their mouths? If so, consider the following facts that our research uncovered about American millionaires:
– Only 19 percent receive any income or wealth of any kind from a trust fund or an estate.
– Fewer than 20 percent inherited 10 percent or more of their wealth.
– More than half never received as much as $1 in inheritance.
– Ninety-one percent never received, as a gift, as much as $1 of the ownership of a family business.
Is Inequality In Itself Bad?
One question that arises in this discussion, is whether or not inequality in and of itself is in fact a bad thing. I don’t think it is.
A society that puts equality—in the sense of equality of outcome—ahead of freedom will end up with neither equality nor freedom.… On the other hand,a society that puts freedom first will, as a happy by-product, end up with both greater freedom and greater equality. – Milton Friedman
Inequality provides incentives. Incentives to better yourself, to advance in your training, to work harder, and to gain experience. It provides incentive to those who are talented, innovative or creative. Incentive to take risks, and to try and better yourself and your situation. Without that incentive of possibly improving your lot, how do we improve?
Milton Friedman argues that we shouldn’t be that concerned about income inequality in a free market because some level of inequality is actually desirable in a well functioning economic system, that it is nonetheless unavoidable, and in any event the actual degree of income equality in observed market economies like the U.S. is less than is commonly assumed.
Why Has Income Growth Stagnated While Productivity Has Gone Up?
So why has income growth stagnated while productivity has gone up over the past 30-40 years?
I’m not sure we know for sure, but there are a lot of reasons that people postulate.
- Immigration: “Harvard professor Dr. George Borjas found that high levels of immigration between 1980 and 2000 caused the wages of lower-skilled American workers to drop nearly 8 percent. He also found current immigration levels have resulted in a $402 billion annual wage loss for workers but a $437 billion increase in profits for business owners.” (source)
- Outsourcing: Outsourcing has lead to higher growth, but lower wages.
- Technological Advances: New technologies have lead to companies shedding workers and slicing payroll, while increasing productivity.
- Slow Economic Growth: Economic growth has been low the past decade, between 1-2% in many quarters. Hard to increase wages with such low growth.
- Labor Less Powerful: Labor groups have held less sway in recent years, meaning they aren’t able to
James Sherk, a senior policy analyst at the Heritage Foundation postulates that productivity and wages haven’t been as far off as suggested. Why? Many non wage benefits that have increased substantially in the past 40 years including health benefits, bonuses, retirement benefits, paid time off and other non cash benefits make up to one fifth of average worker compensation. (So average incomes are down by 7 percent, but total compensation is up by 30 percent. )
That still means we’ve seen a 100% increase in productivity to 77% increase for wages. But Sherk contends that total compensation, properly adjusted for inflation, has kept pace with properly-measured productivity, on average. Also, the growth of productivity hasn’t been as large as has been thought. So according to his analysis it really isn’t that far off.
What Happens When We Try To Legislate Higher Wages?
Many have suggested that we should raise the minimum wage to help increase incomes and reduce the gap. Trying to legislate increases in minimum wage have unintended consequences though too, mainly increased unemployment.
Economists David Neumark and William Wascher reviewed more than 100 studies on the minimum wage in a paper for the National Bureau of Economic Research: “Minimum Wages and Employment: A Review of Evidence from the New Minimum Wage Research.” Here’s a summary of their findings: “The oft-stated assertion that recent research fails to support the traditional view that the minimum wage reduces the employment of low-wage workers is clearly incorrect.” What’s more, almost all the papers they reviewed “point to negative employment effects” for the U.S. and many other countries. The effect is greater for low-skilled `workers, whom the minimum wage is designed to help. Overall, the authors found very little evidence of positive effects from raising the minimum wage. (source)
So the minimum wage increase does indeed help some of those low skilled workers it is designed to help, but the study found that many of the wage increases lead to less jobs for those low skilled workers. Something to definitely consider.
There is still plenty people can do to improve their situation. Try not focusing too hard on the 1%, and do your best to improve your situation.
One main area you can improve? MIT Economist David Autor says it’s important to improve your skills through schooling because those skills are still at a premium (even if the premium has leveled off the past decade or so)
From 1980 to 2012, inflation-adjusted, full-time earnings of college-educated males increased anywhere from 20 percent to 56 percent, depending on whether they also acquired graduate degrees. Conversely, real earnings of high school graduates fell 11 percent, and earnings of high school dropouts fell 22 percent.
The single most important factor is the rising return on postsecondary education. There was a sharp deceleration in production of newly minted college graduates from about 1980 forward, and that led immediately to a growth in the skill premium. After 2005 there’s been an acceleration in production of college graduates, and you see the skill differential start to plateau. If you had to give a person a single piece of economic advice, it would not be: Act like Gatsby and try to get into the top 1 percent. It would be: Go get a college education at a decent school.
So what are some things we can do to be upwardly mobile?
- Get a college education or marketable skills: Add value and take advantage of the premium put on marketable skills. Make sure to choose a major with a good ROI.
- Invest early and often: Start accumulating your own capital like the wealthy do.
- Be entrepreneurial: Find ways to increase your income by branching out, being entrepreneurial and taking calculated risks.
- Diversify your income: Find ways to make income from other sources than your day job. The more diversified you are the less risk you have of losing any one source.
What are your thoughts on income and wealth inequality? Is it a real problem, and is there anything that can be done about it even if it is?