Politics and Policy - The Truth about Income Inequality

With the 2012 Presidential elections quickly approaching and the successful outcome for challenger Romney during the first presidential debate, one must expect the Obama campaign to step up efforts in attacking Governor Romney’s wealth and further emphasize the notion of income inequality.

In our opinion, this argument is divisive and harmful for the economy. By pitting the “99%” against the “1%” and running on a platform of envy, the Obama campaign has twisted this populist fodder into an election year topic that many are taking seriously. Voters that do not fully understand the dynamics surrounding income inequality may be “tricked” into believing redistribution will solve the struggles of our economy.

 True Income Inequality

 There are inherent dangers in grabbing snippets and sound bites from the main stream media surrounding the occupy movement and those greedy rich folks. Income inequality as defined by many left leaning economists and the Congressional Budget Office draw their conclusions from taxable income as reported by the IRS.

There are many flaws in this analysis that lead to misrepresentation of the facts. While it is true that the gap between wages for the top 1% of earners and the remaining 99% has widened over the years, looking at that gap just based on wages in misleading. What this analysis fails to take into account are the increases in non-cash benefits bestowed on the 99%.  For one, the dramatic rise in health insurance has been prevalent over the years and much of this increased expenditure is absorbed by employers and government. According to an article posted by Michael F. Cannon from the Cato Institute, “If one analyzes data on only working-age individuals (age 25–61), inflation-adjusted real pre-tax, post-cash-transfer money income grew 1.9 percent and 10.5 percent respectively for the first (poorest) and 10th (richest) deciles from 1995 to 2008. But if one adds the value of health insurance, the first (poorest) decile grew 12.3 percent while the top decile grew 11.7 percent.”

Additionally, there have been changes in our tax code that is overstating the income gap when compared to past cycles. According to further research at the Cato Institute, “These tax changes caused businesses to switch from filing under the corporate tax system to filing as individuals, and executives to switch from accepting stock options taxed as capital gains to nonqualified stock options taxed as salaries. Simultaneously, the reductions in income-tax rates in 1986 caused much previously unreported income to show up on tax returns.”  

They go on to point out, “Similarly, many studies looking at low-income Americans fail to account for non-cash social-welfare benefits such as food stamps, housing subsidies, and Medicaid. Fully accounting for all of these factors suggests that the gap between rich and poor may not be nearly as large as thought, and that inequality may not be growing at all.” This is a key insight given the number of people on food stamps is up almost 12 million (34%) since June 2009.

Another fact to point out has been the structural shift in the U.S. economy from a manufacturing based economy to one focused on technology and professional services. This will put greater emphasis on education as the gap has widened between college graduates and those solely with a high school diploma. Clearly this change in our economic skill set is not the fault of those evil rich folks but a healthy evolution that is the American economy.

 The Truth about Income Inequality

There are two things we need to realize about this pie that makes up the 1% and 99%.

The pie is both fluid and dynamic.

Fluid in that the top 1% is consistently changing. Research shows the top 1% of the pie is ever changing. Turnover among the top 1% is estimated to be roughly 20% to 30% on an annual basis.  

This is an important point because it captures the essence of the American dream. If one works hard, the benefits of that hard work will pay off and an individual will build wealth and security for themselves and their family.

Redistribution does not support this thesis. Attempting a forceful unification, taking from the 1% and distributing to the 99% will stymie those risk takers, entrepreneurs and future leaders. By eliminating the motivation to reach the status of the 1% in the name of helping the 99%, the outcome will ultimately harm those that redistribution is portraying to protect. 

The Romney campaign needs to stress the importance of opportunity equality and create an economic environment that doesn’t demonize the success of others but clear the way for those that strive to become part of that 1%.

The pie is dynamic as well. The Obama campaign, when pitting the 99% against the 1% makes the assumption that the pie is static in size. In reality, the pie is ever growing, and while many individuals may never reach the 1%, there needs to be an understanding that the success of the 1% greatly influences the living standards of the 99%.

Many of our grandparents never entertained the thought of having a television or an automobile. Many of our parents never dreamed of personal computing and cell phones. Today I observe my four year old son using an ipad with great ease. One needs to consider those great achievements of the 1% er’s that founded Apple, Microsoft, Ford Motor, Wal-Mart and the many other business people that have improved the quality of life for so many 99% er’s. In fact, there has been work done showing an inverse relationship between income inequality and employment and poverty.

It strikes me as a little sad when seeing an “occupier” lashing out against the evils of Wall Street while holding an iphone. It is this very same financial arm of our economy that finances new, innovating and life changing products that are used everyday.

The Right Message

The general public needs to understand the facts about income inequality and be aware of its manipulation for the purpose of political gain.

The Romney camp should illustrate the importance of capitalism as the American way and the inevitability of income inequality. We need to switch the conversation from income inequality to opportunity equality. We need to replace the words envy and bitterness with motivation and drive. We need to revive that entrepreneurial spirit that has made this country the best on the planet. We are not 1% and 99%. We are 100%. We are Americans and should embrace free market principles.

 - Joseph S. Kalinowski, CFA

 

   

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