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How Monetary, Tax, and Regulatory Policy Have Increased Income Inequality Since 1971

 Multiple forces within economic, monetary, tax, and regulatory policies have worked to produce a marked increase in income inequality since 1971. By multiple measures, income has become much less equal in the United States over the last 40 years. An examination of the contributing forces that caused the increased inequality shows that often the inequality is not the product of an Adam Smith free market. Rather, the income inequality is in many ways the result of the collusion of big business and big government.

The widening income gap has been in the news recently. A New York Times article contrasts the 30 years of rapid, broad economic growth from 1945 to 1975 with the slow, concentrated growth from 1980 to the present. From 1976 to 2007, the share of total income for the top one percent rose from 8.9% to 23.5%. According to the Times article, average inflation-adjusted hourly wages declined 7% during the same period. The Institute for Policy Studies (NYSEARCA:IPS) finds concurring evidence regarding CEO pay. Keep in mind that the years detailed are a period of widespread suffering culminating in record breaking poverty levels, and consider this from Institute for Policy Studies: "Corporate executives, in reality, are not suffering at all. Their pay, to be sure, dipped on average in 2009 from 2008 levels, just as their pay in 2008, the first Great Recession year, dipped somewhat from 2007. But executive pay overall remains far above inflation-adjusted levels of years past. In fact, after adjusting for inflation, CEO pay in 2009 more than doubled the CEO pay average for the decade of the 1990s, more than quadrupled the CEO pay average for the 1980s, and ran approximately eight times the CEO average for all the decades of the mid-20th century. American workers, by contrast, are taking home less in real weekly wages than they took home in the 1970s." IPS reports that CEO pay has increased from an average of 30 times the pay of an average worker to an average of 263 times the pay of an average worker.

Perhaps the broadest measure of income inequality is the Gini Coefficient, a number between 0 and 1 that represents the inequality of wealth distribution in a population. The higher the number, the higher the income inequality. In November 2009, Denmark had the lowest Gini Coefficient (.247), and Namibia had the highest (.743). From 1971 to 2010, the US Gini Coefficient grew from about .39 to 47, a 20% increase.

It is fairly settled that income inequality has increased appreciably in the United States over the past 30 to 40 years. Over the last several decades and over the last few years, the rich have gotten richer as the poor have gotten poorer. Whether this is as undesirable as many social scientists, economists, politicians, and struggling workers contend is debated. Specifically, is the inequality such that it warrants changes in government policy? Before getting into details, perhaps the most dramatic argument to make is a simple question of where would you want to live? The countries with the highest income inequality are Namibia, Comoros, and Botswana (all impoverished nations), and the countries with the lowest income inequality are Denmark, Japan, and Sweden (all wealthy nations). The British Medical Journal attempted to correlate income inequality with public health and found that "income inequality is accompanied by many differences ... which may adversely influence health." The study concluded that "reducing health inequalities and improving public health in the 21st century requires strategic investment in neo-material conditionsvia more equitable distribution of public and private resources."

In a Psychology Today piece, Ray B. Williams questioned, "Will income inequality cause class warfare?" Williams suggests that income inequality causes other social inequality and that it could create class warfare in America. Life expectancy within the United States no longer ranks at the top of the world, and life expectancy is actually falling in some U.S. counties. According to Williams, "Research indicates that high inequality reverberates through societies on multiple levels, correlating with, if not causing, more crime, less happiness, poorer mental and physical health, less racial harmony, and less civic and political participation."

The proper measure of the wealth of a nation is not how its richest man lives, but rather how its typical man lives. There should be no debating whether extreme or increasing inequality is undesirable. The only debate should be about what are the causes and what are the solutions.

First among the causes of income inequality is the continuous inflation brought about by the Federal Reserve System. In 1971, we left the gold standard with the end of the Bretton Woods agreement. This paved the way for constant, uninterrupted, positive inflation. Research by Emmett Welch showed that, during periods of inflation, growth in the retail price of goods and services actually outruns the growth within wages. Simply put, while wages increase, after adjusting for the increased cost of living, the typical worker is actually worse off. By the same token, during periods of deflation (falling prices), wages do fall, but retail prices fall further so that, after adjusting for the lower cost of living, the typical worker has actually received a pay raise. Welch's research tells the story of prices running to unsustainable levels relative to income during inflationary periods, and the deflationary periods restoring balance. Current economic policy subscribes to the theory that deflation equals depression and must be avoided at all costs. Nobel Prize winning economist Paul Krugman explained the mainstream academic belief about deflation being bad in an August 2010 New York Times opinion piece. Krugman and all who subscribe to his popular belief overlook some important facts:

  • In 2004, UCLA economist Andrew Atkeson and U. of Minnesota economist Patrick Kehoe showed the contrary: In 17 countries studied over a span of more than 100 years, deflation correlated with depression only once.
  • review of pre-Federal Reserve History by Ohio State U. economist Richard H. Steckel reveals that deflation coexisted with strong economic growth for more than a hundred years in the United States.
  • The lower one's income, the greater portion of it is consumed, and within that consumption, an even greater portion is spent on necessities. Intentionally devaluing a currency through inflation increases the cost of necessities and thus disproportionately hurts those in the lowest income brackets.

The effects are complex and controversial, but an objective review of history suggests that current US policy is a contributing factor towards income inequality.

Second among the causes of income inequality is that tax policy has changed significantly since 1971, and many of the changes have been to the detriment of the average worker. Broadly speaking, as a percent of total tax revenue, corporate taxes have decreased, and payroll taxes have increased. (Source: Tax Policy Center, Urban Institute and Brookings Institute.) Payroll taxes are a highly regressive tax; i.e., they tax lower incomes at a higher percent than they tax higher incomes. This is because the bulk of payroll taxes (Social Security taxes) are capped at a certain figure (currently $106,800). Once someone earns $106,800, he pays no Social Security tax on income over that amount. The increased dependence on payroll taxes has shifted the tax burden downwards. Top marginal rates have also fallen from 70% in 1971 to 35% in 2010.

Finally, the most overlooked contributor to income inequality is increased governmental regulation since 1970. Jacksonville State U. finance and economics professor Christopher Westley argued in 1998 that there is a statistical relationship between increased government regulation and increased income inequality as measured by the Gini Coefficient, and that increased government regulation increases the cost of low-skilled labor relative to high-skilled labor. Business regulation is a contributing factor to monopoly power. Commonly accepted microeconomic theory states that a monopolistic firm will produce less at a higher price than a perfectly competitive firm will produce. Ultimately, this increases prices and has the same effect of reducing real wages. Unfortunately, those who are most likely to take an anti-government, anti-regulatory stance, are also the least likely to be concerned about social justice and income inequality. By the same token, those who are most concerned about social justice and income inequality are also the least likely to advocate any reduction of government power.

Ultimately the explanations for income inequality can be described as not related to a free market. Central banking such as the Federal Reserve System is central planning, not free market. Tax policy that shifts the tax burden downward is a function of government, and increased government regulation is anything but a free-market principle. The solution to each problem would be an injection of free-market principles, with the noted exception of tax policy. Regarding tax policy, there is no argument but a general fairness argument at the assertion that those who benefit most from the existence of government should pay the most to support it. Perhaps we should not be surprised by any of this. We should not be surprised that rules made by those on top of society tend to favor those on top. What we can do, however, is understand them, and unite on a common platform to change them. With the exception of tax policy, free market, small-government-minded Libertarians and big-government-minded social-justice Progressives should be able to unite to end the Fed and to scale back government regulations regarding occupational licensing

Disclosure: none