Updated: Nov 19, 2019
What is the best way to solve the income inequality issue?
What are our options?
I am not a political person, I’m a retired rocket scientist, but the income inequality issue sounds like it’s real and it’s liable to bring major changes in our way of life, so I thought I would address it. The best way to explain what has happened is with a couple of charts so see Figure 1 below which is right out of the November 4th Wall Street Journal.
Figure 1 –Net US Incomes by Quintile (20%) Corrected for Government actions
The red earned income line and the blue net income line come from tax and census data and shows the overall income situation after taxes and all transfer payments such as food stamps, Medicaid, Welfare, etc. It is probably the best place to start since it shows net income across all quintiles and net income data after taxes and transfer payments is not readily available, as you will see later. These curves shows’ us that the ratio of net income between the top quintile and the bottom quintile is approximately 4 to 1. Remember that number because there is plenty of controversy to come.
What is the principal cause of income inequality? There are many, many reasons, as shown in figure 2 below. Some are tied to personal attributes, and some are tied to an overall loss of well-paid jobs during the early 21st century. We’ll try to address those shown in figure 2 in order.
Figure 2 – Drivers of Income Inequality
Technological Change – Loss of jobs through automation of skilled and unskilled jobs has been a major factor in reducing income among older lesser-skilled workers who can’t or won’t take additional training. Also, many of the “new” jobs require relocation which is hard for older workers.
Trade Globalization - Increased global trade drives increased efficiency and rewards highly skilled labor, but this often moves jobs away from marginal domestic industries, increasing unemployment.
Financial globalization – Creation of International Centers of Excellence drive up the incomes in higher skill and technology-intensive sectors to the detriment of workers with similar skills back home.
Labor Market Institutions – Erosion of Union jobs through industries being outmoded or replaced has stagnated the wage growth for unskilled labor, especially since 1980. An additional issue has been the recent emphasis on corporations rewarding their stockholders above their employees and neighbors. This changed during the 1980s in the MBA programs taught at major universities. I personally witnessed this at my job at the Boeing Company. In the late 1980s new managers were sent to obtain MBAs and they came back with a "reward the shareholders" mentality. Suddenly valued employees were just numbers on spreadsheet and jobs were moved overseas where salaries were less. Layoffs started and morale plummeted.
Tax Policies – Government programs such as Progressive Income Taxes, Food Stamps, Medicaid, and other Social Wealth Transfer Programs have tried to maintain a fair balance between the top 25% and the bottom 25% earners (remember 4:1).
Education (or the Effect of Personal Attributes) – I’m going to expand the final box in figure 2 because I think education is only part of the story. The primary personal attributes relative to income levels are perseverance, intelligence, and education. Perseverance encompasses the personal drive to succeed and accomplish your goals. Many people accomplish great things and earn a good income without high intelligence or higher education by working hard, saving money, and expanding their businesses. For those blessed with high intelligence there are additional ways to succeed because they can qualify for higher education scholarships and even if they shun higher education they can leverage their intelligence in whatever occupation they choose, to move up and prosper. Of course, some people have all three attributes and still fail at making a high income.
There is data to show the connection between education and monetary earnings (not net earnings). This is shown in figure 3 below.
Figure 3 – Comparison of US Monetary Earnings as a function of Income $ and Education Level
The data shown is somewhat counterintuitive. For the lowest earnings the level of education seems to make little difference, and this can be seen in the homeless problem in our major cities. As the earnings level increases to $17,500 per year about 20% of the workers have a college degree as opposed to 50% of the workers who have a high school diploma or less. At $40,000 per year the % of workers with college and high school or less are equal at 35%. As the earnings per year climbs above $40,000 we see a linear increase in the percent with college degrees and a linear decrease in the percent with high school or less. That is the expected result. What this data tells us is that education can help a person to achieve high earnings, but it certainly doesn’t guarantee it, and if you borrowed heavily to finance your education, you may be in worse financial condition than your neighbor with only a high school diploma or two years of Junior College. An interesting footnote is the Williamson College of the Trades which actually prepares at-risk students for well-paid trade jobs. Established in the 1880s as a college for poor boys, Williamson in Media, Pennsylvania has remained true to its mission. The school accepts only young men from modest backgrounds and educates them in vocational trades. The residential programs require students to rise early and present themselves in coats and ties for inspection. More than 70% of the students graduate in three years, and 98% of the graduates find employment. Many of the jobs they step into pay from $75,000 to $100,000, and tuition is free. Similar trade colleges are found in almost every state. The bottom line is that being born as a trust fund baby certainly improves the probability for high income, but it is not a guarantee, and many people born on the wrong side of the tracks do extremely well with respect to income and happiness. Unfortunately, too many of the people born on the wrong side of the tracks make poor decisions and end up living in relative poverty.
Income Inequality varies between Countries (see figure 4 below) – There are parts of the world (Scandinavia) where the population has addressed income equality and installed a social safety net to ensure that nobody gets forgotten and totally left behind. I visited Norway recently and their infrastructure and lack of homelessness is impressive. Of course, the oil monies from the North Sea has helped a lot. As you can see the U.S. is at the other end of the spectrum and that is the fundamental issue I wish to address; Where do we want to be in the income inequality spectrum, and how do we get there? More about this later.
Figure 4 Variation in Income Inequality amongst Countries
First, we need to know exactly how much inequality we are talking about, Figure 5 below shows the average pre-tax incomes in the U.S. in 2014. Of the 234 million adults on the tax rolls, the bottom half earn a median income of $16,000 per year. This is way below the poverty line and there are existing programs to address this problem. The next 40% of the taxpayers earn a median income of $65,000 per year. This is a living wage. I know because I was there in 2014 (adjunct professors in a state-supported university are not well paid). The political hot potato in the U.S. is the top 10% of the taxpayers. The median income for 23 million taxpayers in the top 10% is $304,000 which is probably politically acceptable, if that were the only data available. However, when the median income for the 2.3 million taxpayers in the top 1% of $1.3 M, and the median income for the 234,000 taxpayers in the top 0.1% of $6M is made known, progressive politicians tend to come off the rails.
One of the issues here is that Figure 5 is taxable income and millionaires and billionaires have armies of tax lawyers to hide their real income. Warren Buffet has recently made a famous statement that the percent income tax he pays is less than his secretary pays. This is a sign of the problem we are trying to solve. Figure 5 U.S. Average Pre-Tax Incomes in 2014 by Decile
The distribution of U.S. income has varied over time as shown in figure 6 below. The lower Quintile moved backwards during the 1980s as manufacturing jobs moved overseas but caught up with the second, third, and fourth Quintile during the 1990s. They all suffered because their cumulative growth over the 33 years shown was less than 50%. (1.2% yearly growth). Compare that with the fifth Quintile at 1.6% yearly growth and the top 1% of tax-payers at 2% average growth and you can see the inequality growing.
Figure 6 – Cumulative Inflation-Adjusted U.S. After-Tax Income by Group and Year
We have shown how income inequality has grown over time and this is best shown by showing how net wealth share has varied over the same period. Net wealth for the top 0.1% is shown in red and for the bottom 90% of the population in blue is shown in figure 7 below.
Figure 7 – Relative US Net Wealth over time.
The top 0.1 % lost ground during WWI (U.S. Income Tax initiated), but the bottom 90% suffered during the depression and then really prospered during the boom after WWII. About 1980 our current inequality trend started as the emphasis on shareholder value took hold in business (driven by business schools in that era) and as a result manufacturing moved overseas, and that trend has continued until the current administration took over.
Figure 8 below presents the best current data on relative wealth in the U.S. and you can see why the situation is becoming critical because 25 million people are controlling 2/3 of the total U.S. wealth.
Figure 8 – Control of U.S. Household Wealth over Time
Now that we understand the nature of the problem, what should we do about it?
I think income inequality definitely needs to be addressed, but we must be careful to avoid throwing the baby out with the bathwater. The top 1% got their wealth by investing capital in business ventures that have prospered and created lots of jobs along with the billions of dollars in profits. We need to make our tax code more progressive, so they share those billions with the rest of us. Look at the tax codes for Australia and Canada as good examples. We don’t want to kill the golden goose, but we do need to eliminate many of the tax loopholes the super-rich are using. The top 10% are millionaires, not billionaires, and the more progressive tax code should be sufficient to insure they share their wealth.
For the bottom 90% they need affordable homes, affordable medical care, and safe streets. I wish I had ready solutions, but I don’t. The big Tax Cut passed by Congress last year was supposed to spur investment in existing corporations’, so they could expand and build new infrastructure, creating lots of well-paid jobs. Instead they bought back stock with the extra profits and thus rewarded their shareholders (largely to top 10%). I believe the next version of our tax laws will be much more restrictive, but the corporations brought it on themselves. We also need to revamp our business schools to teach future business leaders to value employees and neighbors as equal or even more important than their stockholders. Members of corporate boards could also force this message across.
I live in Seattle and the concentration of successful business in and around Seattle has driven housing costs through the roof. There is little reason that Microsoft and Amazon need to be located five miles apart and near downtown. There are dozens of small and medium-sized towns along the I-5 corridor in Western Washington that would love to host portions of a technology giant, and these small towns have abundant cheap housing.
Affordable medical care is difficult because it is going from an availability, to a right, and it looks like that is going to take us down the path to the English system, which really nobody wants. The current administration is working on making the current system more transparent and that may help but were in uncharted waters. I suggest we all look at the Netherland’s Health System which is based on mandatory insurance programs, but costs’ less than ours and gives better results.
Finally, we get to safe streets which covers both crime and homelessness. Income inequality plays a part here because a portion of the criminals and homeless (probably around 30%) were driven into their circumstances by a lack of income. The other 70% have mental issues, a dependency problem, or just enjoy living outside the law. While in Norway I discovered they do not a safe streets problem because they arrest both criminals and the homeless and put them into a mandatory lockup where their problems are treated, both mental and physical. They then graduate to mandatory education and job training, and when they graduate that they go into an apprenticeship. This program is expensive, but it seems to have solved the problem.
Something to think about.
In conclusion, Income inequality in the U.S. is a serious problem that needs to be addressed. I wish the industries and the business schools that caused this problem would address it, but I fear we’re going to have to rely on government to fix it. Heaven help us all.