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Fixing income inequality

Written By | Jan 17, 2014

WASHINGTON, January 17, 2014 — President Barack Obama said that income inequality is the “defining issue of our time.” He further said that the decline in economic mobility by 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 also noted that inequality poses a “fundamental threat” to “our very way of life.”

Nobel Prize winning economist Joe Stieglitz 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.” In fact, he says action is needed immediately.

And they are right.

The president’s solution was to raise the income tax, the capital gain tax, the dividend tax, the Medicare tax and other taxes on those who have made the largest contributions and use that money to give it to the bottom 15% 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 that exactly the opposite has happened.

Income inequality has significantly worsened in the past five years. Primarily because of astronomically high rates of growth in the money supply coupled with the Federal Reserve Bank’s policy of buying $85 Billion per month of government debt, the stock market as well as other financial markets, have skyrocketed giving huge increases in wealth to the upper income earners. At the same time the President’s programs have discouraged the bottom 15% 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 stamps. The result was the classic “the rich got richer and the poor got poorer.”

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

Suppose Bob and Ed were hungry, had no food and believed they had no means to acquire food. Jane had been fishing all day and has 10 fish. This represents a very unequal distribution. The President’s solution would be to take 6 fish from Jane and then give three each to Bob and Ed.  That makes the distribution more equal. It does however create two long term problems.

One is that Bob and Ed are now dependent on Jane for food. And two Jane must catch enough food each day to feed herself and two others. In the long term this simply will not work.

A better solution would be to teach Bob and Ed how to fish and also assist them with acquiring 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. Also 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 two, three, four fish or more. The income gap narrows and there are no long term problems.

This points out that 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%, to contribute.

It is the private sector that 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 a rate of 4% or 5% or more. Unfortunately the current policy is doing just the opposite so that private sector struggles to grow 2% or 3%.

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 have not. 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 a Professor of Finance at Stockton University where he teaches undergraduate and graduate courses in Finance and Economics. He has written Op-ed columns in major newspapers for more than 35 years.