Income Inequality, Quadrillionaires, Success, and Failure

There has been a lot written about Gini coefficients, income inequality, the 1%, and potential negative effects on society from overly concentrated wealth. Looking at income distribution in the US does show there is cause for concern. From a 2007 Treasury study, Income Mobility in the U.S. from 1996 to 2005:

U.S. Census data, for example, show that the share of household income of the top 20 percent of households increased from 44.1 percent in 1980 to 50.4 percent by 2005, with the share of the bottom 20 percent decreasing from 4.2 percent to 3.4 percent. Similarly, Piketty and Saez (1998, 2007) find that the share of income of the top 10 percent of taxpayers increased from31.7 percent in 1960 to44.3 percent in 2005, while the share of the top 1 percent increased from 8.4 percent to 17.4 percent.

There has clearly been a significant shift, especially for the infamous 1%. But if wealth guarantees its own perpetuation, then where are all the quadrillionaires? Through the magic of compounding, any family with even a small nest egg a thousand years ago should by now own the world many times over. Yet those people don’t exist, and many of the richest people on earth didn’t inherit their wealth.

If all else is held constant it’s a mathematical certainty that the rich will always get richer. Once a person has money to invest that person will make more than the person whose salary is identical but who has no savings. Those returns from saving and investing can then compound and, given enough time, one person becomes a millionaire while the other remains a working stiff with nothing to show for it.

Yet in the real world things always change. Holding onto wealth, especially for generations, requires making a large number of good decisions in uncertain conditions. Wars, confiscations, banking and currency crises come with alarming frequency, and not always to those other countries. But even without those dramatic factors money can easily be lost. Does anyone really think Paris Hilton’s money will still be in the family two generations from now? Not likely when even next year seems a bit of a stretch. In a free market wealth is only retained by deploying it in ways that satisfy other people enough that they are willing to part with their hard-earned cash. Doing otherwise costs money, sometimes catastrophic amounts.

The same Treasury department study looked at the changing composition of different income groups in the US. The results show a surprising amount of movement between income levels across the spectrum. The key findings:

  • There is considerable income mobility of individuals in the U.S. economy over the 1996 through 2005 period. More than half of taxpayers (56 percent by one measure and 55 percent by another measure) moved to a different income quintile between 1996 and 2005. About half (58 percent by one measure and 45 percent by another measure) of those in the bottom income quintile in 1996 moved to a higher income group by 2005.
  • The composition of the very top income groups changes dramatically over time. Less than half (40 percent or 43 percent depending on the measure) of those in the top 1 percent in 1996 were still in the top 1 percent in 2005. Only about 25 percent of the individuals in the top 1/100th percent in 1996 remained in the top 1/100th percent in 2005
  • The degree of relative income mobility among income groups over the 1996 to 2005 period is very similar to that over the prior decade (1987 to 1996). To the extent that increasing income inequality widened income gaps, this was offset by increased absolute income mobility so that relative income mobility has neither increased nor decreased over the past 20 years.

With that amount of reshuffling it’s not hard to make a case that the worries about income inequality are overblown (see U.S. Income Inequality: It’s Not So Bad). Individual incomes are quite variable over time so no one is necessarily stuck at any level. The numbers at the individual level are more a reason to celebrate and aspire than to seek redistributive solutions.

So is it case closed, nothing to worry about? Not quite. If it were indeed a free market and both the overall distribution and the individual movements within it were entirely the result of math and each individual’s choices and actions, then there would be nothing to worry about. If people were tired of Zuckerberg being a billionaire they could all quit Facebook tomorrow and the problem would be solved in a few days. Unfortunately, in the last two decades that sort of event has all too often not been allowed to happen.

A cornucopia of interventions have been deployed to enforce the status quo and prevent wealth from moving from the incompetent to those that best serve the desires of the populace. Bailouts, trade barriers, subsidies, tax breaks, regulatory burdens, government contracts, enforcing patents and IP, selective enforcement of laws, and a plethora of other corporate welfare all create an uneven playing field and prevent capital from being redeployed to its most productive use. Inflation transfers wealth to those who first receive the new money and credit and takes it from those last in line, often retirees and those with low incomes.The recurring crises that result from credit expansion inflict the most harm on those without the income or means to escape the effects.

All interventions in some way choose winners and losers based on something other than the voluntary choices of individuals about how to spend their money. This isn’t just immoral (as argued here regarding price stability), and not just about the risks from creating moral hazards, but about forcibly altering the structure of society in ways that benefit only a favored few. If the finger of blame for inequality in the US is to be pointed anywhere, it should be pointed there. Increasing standards of living and a free society require allowing failure just as much as success.

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