Dubiously Free Trade, Individual v. Collective, Live and Learn

Wealth Inequality in America: A Partial Critique

So I’m a little late on this one, but there is a viral video on wealth inequality in the United States going around that compares what a survey of 5000 Americans said they thought wealth inequality should be and then compared that to what it actually is. Well, as many of you know, wealth inequality is substantially larger than most Americans think it is:

Now I should start off by saying I agree with this video in part. Wealth inequality in the United States is too high and it’s getting worse. While proponents of free markets rarely complain about income inequality directly like say Joseph Stiglitz, they do complain a lot about corporate welfare. Tim Carney’s book, The Big Ripoff, is to me the best rundown on the whole bloated mess. And what would corporate welfare probably lead to… well, more income inequality.

That being said, there are problems that should be highlighted. Some of these problems relate to what is considered wealth but the big one is actually a sort of meta-problem with the way that normal people think about inequality. In other words, what people think inequality should be doesn’t make any sense if they actually think about. Why you ask? Well, let me explain:

1. The Big Missing Variable

The big missing variable when discussing income inequality is increased exponentially in terms of it’s importance when discussing wealth inequality. Indeed, it may be startling to think of how simple a variable this is.

Age.

It seems obvious now that you think about it, doesn’t it.

After all, how much money were you making when you were 25 compared to 45. Probably less than half. But when it comes to wealth, oh lord, it’s not even close. The wealth inequality figures discussed in the video make no attempt to control for age. And as a matter of fact, the gap in wealth between the young and the old has been growing.

According to a Pew study, the net wealth of those over 65 between 1989 and 2009 went from $120,000 to $170,000, a 42% increase. For those younger than 35, their wealth actually decreased from $11,500 to $3500, a 68% decrease. And more importantly, $170,000 is 4850% of $3500!

Now remember that these aren’t the same people being measured over time. Perhaps this has something do with people going to college more and thereby 1) starting their career later and 2) having a lot of student debt to pay off. Thereby they’re worth less when they’re young, but more when they’re old. Or perhaps kids these days just don’t know how to save like they’re folks did.

But when you boil it down, people under the age of 44 only possess 11% of the wealth in the United States. That’s an incredible figure if you think about it. And remember, these people are going to get older. They’re going to pay off their student debts, get that big promotion, pay off their house, inherit their parents wealth, etc.

For example, take this thought experiment; say everyone in the country made the same income, but each decade of life they got a promotion. They start at $20,000/year in their 20’s, then they go to $30,000/year in their 30’s, etc. In addition, they save 5% of their income each year and make no return on their savings. Assuming there are as many people in their 70’s as 20’s (which of course there aren’t, but bear with me), this is what the income and wealth inequality would look like:

Wealth inequality Spreadsheet

Or as the video presents it:

Wealth Inequality Graph

And that’s assuming that everyone is equally talented, that every industry is equally as profitable and that everyone has just as good of saving and investment habits. Furthermore, if I put in just a small return, that chart would be skewed even more. At 3% interest, if the person contributes every month, on their 30th birthday they will be worth $11,627. On their 60th, they will be worth $198,486. In that case the bottom 20% is worth only 2.69% and the top is worth 45.6% of the total. And that acts as if everyone in their 20’s is worth over $10,000 when in reality most are worth next to nothing.

Any serious look at wealth inequality, and income inequality for that matter, has to take age into account.

2. Entitlements

OK, our entitlement systems are a little underwater, but ignore that for a second. Payroll taxes are capped at $113,000, so in some ways it acts as a regressive tax. But then again, it’s not supposed to be a tax, it’s a government mandated insurance scheme.

Well, throwing in Medicare and Social Security add a little for the rich, but they do add a substantial amount of wealth to the poor in relative terms. How much more wealth would the poor and middle class have if instead of paying into a government program they were mandated to put that money in a health savings account or IRA or something to that effect? Well, it would be quite a bit. This would smooth out the curve a bit. While it makes sense that the author of the study don’t include entitlements since it’s based on when you need it (Medicare) or how long you live (Social Security), conceptually, we need to take them into account.

So let’s take a shot at it. According to Bankrate.com:

… A male average earner who retired at age 65 in 2010 paid out $345,000 in total Social Security and Medicare taxes, but will receive $417,000 in total lifetime benefits ($464,000 for a woman)… In the case of a household with only one wage earner, the taxes paid out were $345,000, but the benefits received by both parties will be $778,000. For two-earner couples where one earned the average wage and the other earned a low wage ($19,400), tax payout was $500,000, but benefits will be $800,000.

OK, that doesn’t sound particularly sustainable, but if that average person is taking out some $400,000 plus in benefits, couldn’t that be thought of as a form of wealth?

3. Individuals vs. Families

In the video, the narrator describes the survey as separating the American population into “groups.” Groups of what? Well he doesn’t say. Luckily the links in the lowbar did. And you guessed it, it’s family wealth, not individual. Once again I have to clarify this ridiculous error. When family sizes vary in shape and size you simply cannot compare them as if they were the same. As Thomas Sowell has noted:

 Households are of different sizes, they vary over time, they vary from one group to another, they vary from one income level to another. So for example, there are 39 million people in the bottom 20% of households, and 64 million in the top 20%. So you’re saying, yes, 24 million additional people do tend to have more money.

Or in other words, the top 20% has almost 60% more people in it than the bottom. Even if there were an equal number of people in the other three “groups” and every individual had the same wealth, the top 20% would have almost 25% of the wealth and the bottom 20% would have barely 15%. When we further take into account that many in the bottom 20% are in prison, single parents, people on welfare, disabled, drug addicts, homeless, etc. it becomes clear that dividing the country into such groups is simplistic at best.

In Other Words…

Now again, even after all that, I do think this is a problem. And I will join liberals in denouncing the major role corporate welfare played in all of this (and I would add, Federal Reserve policy). However, before liberals get too far into their rant about about taxes being too low and regulation being too light, I should note some other possible reasons.

1. Immigration: I believe the impact is relatively small on income inequality (David Card, for example estimates it’s share is only 5% of the increase between 1980 and 2000), I do think it’s effect on wealth inequality is large. Most immigrants, after all, come to the United States relatively poor.

2. Dependency and Welfare: Charles Murray’s new book, Coming Apart, makes the case that the values of the upper class and lower class have diverged, and I do think there’s something to this. Indeed, while in 1960 only 9% of men in the bottom 30% between the ages of 20 and 64 were working. In 2000 it was 30%! In 1996, only 0.286 people in single person households in the lower median worked. It’s hard to increase one’s income, and very hard to increase one’s wealth when you aren’t working. How much has this separation in values played a part? And oh by the way, the decline in marriage probably hasn’t helped either.

3. Technology: I think this is the big one. Charles Murray touches on it a lot as have many others from all across the political spectrum. To use Murray’s example, in the 60’s, someone who was really good at math could become a math teach and make a decent living. Today they could go work for a Quant Fund on Wall Street or maybe for Google and pull seven figures a year. Or take music. Back in the day, musicians wasn’t such a feast or famine gig, because there were no recording devices. So the gigs were how you made a living. Today there’s a bunch of starving artists and a few megastars. And then of course there’s automation and robots and computer algorithms that are making lower end manual labor jobs less necessary, and they’re starting to do a number on service jobs as well.

In other words, the problem is complicated. I do think globalization plays a role (although I think it plays a role in lowering poverty levels around the world too). And of course it should be mentioned too that people have different levels of talent and produce different levels. Those who produce the most should be rewarded. And without some inequality, there’s no incentive, at least no material incentive, to work hard and bring great products and services to the market.

It’s just that inequality is too high. And while that’s still a subjective opinion, I think it rings true for most of us. Just be careful to wade through these statistics before yelling that the sky is falling.

___________________________________________________________________________________________________

For more Swift Economics, subscribe now to our RSS Feed
Follow Swift Economics on Twitter
LIKE Swift Economics on Facebook

Standard