Quick Solution to the “Rich-Poor Gap”

by Gregory Rehmke · Published September 6, 2014 · Updated October 27, 2016

Students researching the topic on the values of freedom and equity in the realm of economics will be interested in the new Federal Reserve survey showing an increasing gap between rich and poor, or “richest and poorest,” as this September 4, 2014 WSJ article labels them:

The gap between the richest and poorest Americans widened even as the U.S. economic recovery gained traction in the years after the recession, the Federal Reserve said.

Average, or mean, pretax income for the wealthiest 10% of U.S. families rose 10% in 2013 from 2010, but families in the bottom 40% saw their average inflation-adjusted income decline over that period…

Before reviewing this new survey data on the recovery, it is worth noting that in recessions the rich lose more than the poor. They have more to lose, after all. Wealthy people usually have money invested in the stock market and in real estate. When a recession hits, stock and real estate prices fall, often by a lot.

Poor and low-income people often rent, and rents usually don’t increase during a recession (the rent is too darn high, after all). Middle and high income people nearly always own one or more homes. A 2011 report:

Since the peak in 2006, home values nationally are down 29.5 percent, Zillow says. Compared to this time last year, prices are down 8.2 percent nationally.

Most middle and high income people not only owned one or more homes, when the recession hit, but most had borrowed to buy homes which leveraged their losses, so the 30% average price drops wiped out home equity for millions.

Many middle and high income people fared as bad or worse in the stock market when the recession hit:

The widely watched Dow Jones Industrial Average hit its all-time high on October 9, 2007, closing at 14,164.43. Less than 18 months later, it had fallen more than 50% to 6,594.44 on March 5, 2009 (Source: About News)

Investors are usually not as leveraged in the stock market as they are with their home mortgages, but many owned financial instruments that were as leveraged, since they held portfolios of derivatives based on often shaky home loans.

The 2007-2009 financial turmoil and recession was a big political and economic mess, and, many argue, was made worse by the government interventions that followed. For more on this see The House that Uncle Sam Built (pdf here).

However, if reduced income and wealth inequality are the goals, recessions provide an effective means. The 2007-2009 recession dramatically reduced wealth inequality in the United States and Europe. Rich people lost a boatload of money, far more than the poor because one, they had more to lose, and two, most had invested in stock and real estate.

The WSJ article noted this part of reality: “During the recession, income distribution narrowed as top-earning families saw their incomes fall.”

Poor and low-income people lost too, with many losing their jobs and those who recently managed to become homeowners near or at the housing peak, lost everything and more. Federal Reserve, Fannie Mae, and Freddie Mac policies combined with over-enthusiastic companies in the real-estate ecosystem to pump up the housing bubble (as discussed in The House That Uncle Sam Built and many books and other articles.)

So, back to the original Federal Reserve study, it should be no surprise that recovering from a recession increases the “gap” between rich and poor in much the same way that recessions decrease the gap. As stock prices recover it stands to reason that the people who own stocks will benefit. Poor and lower-income people usually don’t own stock or have other savings or investments, so steadily rising stock markets won’t raise their income or wealth directly.

The Wall Street Journal article continues:

Widening income inequality has gained increasing attention over the past year from economists, policy makers and the wider public amid concerns over the uneven gains of the economic recovery.

This quote refers to studies by Thomas Piketty and colleagues research claiming increased income and wealth disparities in recent decades. Piketty’s book was a smash hit (for an economist), titled Capital in the Twenty First Century. See earlier posts on the income inequality debate and the book here and here.

NCFCA LD topic: Resolved: In the realm of economics, freedom ought to be valued above equity.

More from the WSJ article, drawing from the Federal Reserve survey:

Average income rose last year from 2010 for homeowners, non-Hispanic whites and households headed by a person with a college degree. Average income fell for renters, nonwhite and Hispanic families and households headed by someone without a high-school diploma.

The median net worth of American families tumbled during the recession years. While the situation has stabilized, families haven’t regained their lost ground, Thursday’s report revealed. Median net worth fell 2% in 2013 from 2010, while average net worth was basically flat.

Statistics can mislead, and students debating equity and equality issues should be familiar with averages, means, and medians.

An April 28, 2014 report from the Migration Policy Institute notes:

Thirty percent of the 40.8 million foreign born residing in the United States in 2012 entered between 2000 and 2009, 7 percent entered since 2010 …

Consider the WSJ/Federal Reserve report: “Median net worth fell 2% in 2013 from 2010, while average net worth was basically flat.” Median means the middle, so with half of households above and half below, the median income fell slightly (by 2%). One factor pulling that median down is the 2.8 million immigrants that arrived since 2010. Some rich immigrants, but most far below average, mean, and median incomes.

Don Boudreaux discusses other issues, disagreements and debates on income measurements and cost-of-living adjustments with income statistics in this LearnLiberty.org video (linked earlier with Robert Reich video on inequality):

And finally, looking back at the title of this post, a note on the proposed Quick Solution to the “Rich-Poor Gap.” In some sense Bill Gates illustrates the “real problem.” As of September 5, Forbes says Mr. Gates is worth some $81 billion. The total wealth of the 400 richest people is the U.S. is $2 trillion dollars.

If our concern is fairness and equity, then our focus should be fairness in spending and enjoying money, rather than just having money. Mark Zuckerberg owns about 30% of Facebook stock worth some $25 billion dollars. Owning one-third of the company gives Mr. Zuckerberg a lot of power in running the company, just as Mr. Gates large block of Microsoft stock provided him as CEO for many years.

Board members and other stockholders would have a hard time firing Mr. Zuckerberg even if they thought he paid too much for Instagram or WhatsApp. If Steve Jobs had owned 30% of Apple stock (or even 10%), it is unlikely he would have lost power and been forced out of Apple (he was forced out, but later returned to save the day).

So Mr. Zuckerberg “enjoys” his billions of dollars worth of Facebook stock in the sense that it gives him job security allowing him to take risks and keep pushing the envelop, and not to worry so much that Wall Street investors might try to replace him whenever stock values tank. Still, those billions of dollars of assets can’t spent without losing job security.

For the Forbes 400 and their $2 trillion assets, would it make things more fair if they all agreed to keep their wealth invested to support jobs, innovation, and enterprise? Say all the country’s billionaires agreed to keep 99% of their wealth invested in enterprises and the economy, and not to spend more than 1% of their total worth each year? Would that satisfy those who complain wealth is too concentrated at the top?

The fact is that very wealthy people tend to keep nearly all their wealth invested. The money they spend helps the economy in the short term and can create jobs. But assets invested, especially by successful entrepreneurs, tends to be wealth-creating as well as job-creating.

By thinking of 99% of the assets of the very wealthy “locked” in productive investments of various kinds, the effective wealth gap between rich and poor in America is significantly reduced. It is best I think to focus on expanding opportunities for poor and low-income people to raise their incomes and savings rate.

Of course, no one likes being told what they can and can’t do with their own money. Especially really rich people. My point is that rich people have most of their wealth locked up in long-term investments. And most would struggle to spend 1% of their wealth. Sixty-one billionaires didn’t make the cut for the 2013 Forbes 400 list and the folks with $1.27 billion who didn’t make Forbes list would have to spend $12.7 million plus their investment earnings to hit the 1% spending limit I’ve proposed. My guess is that few of the ultra-rich would be able to spend even 1% of their wealth and income in a year.

So does all that concentrated wealth really matter? Does anybody lose because some people have created so much wealth or inherited so much from their parents? The very wealthy have most of their wealth invested in assets and enterprises that make the world a better place.

Quick Solution to the “Rich-Poor Gap”

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