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Growing Income Disparity

Policies Designed to Reduce Economic Inequality Are Bound to Fail

SEPTEMBER 01, 1996 by HANS SENNHOLZ

No matter how you may gather the data, the gap between the most affluent Americans and everyone else is widening. According to a Census Bureau report, the share of national income going to the top 20 percent of households increased from 40.5 percent to 46.9 percent between 1968 and 1994. Since 1994 the trend has even accelerated. At the present rate of growth, the top 20 percent of households may soon earn more than one-half of national income.

Most legislators and regulators are puzzled and alarmed by this widening income disparity. It’s the very opposite of what they hoped to achieve. They spent trillions of dollars since President Franklin Delano Roosevelt found “one-third of a nation ill-housed, ill-clad, and ill-nourished” and President Lyndon B. Johnson declared “war on poverty.” President Bill Clinton discovered that “the rich are not paying their fair share,” which in 1993 led to stiff tax increases for upper-income Americans. Yet, the gap continues to widen.

It is ironic that the spenders create the very pressures that cause interest rates to rise and capital income to soar. They incur huge budgetary deficits which crowd out business investments, consume capital, and raise interest rates. Simultaneously, they cause wage rates to stagnate or even fall. After all, it is the amount of capital invested that determines productivity and wage rates; to consume capital is to destroy jobs and depress wage rates. The U.S. government is consuming capital en masse, which makes it a driving force for the growing inequality.

The United States enjoys a great stock of productive capital created in the past. But it is one of the worst cases of current saving in the industrial world. U.S. net savings, which are the sum of personal savings and retained business earnings minus total public-sector deficits, amount to less than two percent of gross domestic product. This compares with some seven percent until the late 1970s when the federal deficits were relatively small. Consequently, interest rates have risen steadily as has capital income. Thirty-year treasury bonds now yield more than seven percent, mortgages and mortgage-backed securities more than eight percent.

The Federal Reserve System is adding its weight to the disparity. For several years it conducted easy money policies that pushed stock and bond prices to dizzying heights and created a financial bubble, perhaps the biggest ever. While real hourly wages have fallen since the mid-1970s and many high-paying jobs in manufacturing have disappeared, stock market investors have reaped extraordinary profits. The lion’s share of these profits obviously went to the top 20 percent of households. As long as the bubble lasts they are likely to enjoy the disparity.

The rising burden of corporate taxation and regulation has the same effect. It makes it rather difficult to build plants and factories, stores and warehouses, office buildings and other structures. It forces corporations to embark upon a course of downsizing which consists primarily of labor shedding, asset shuffling, and merg ers. It depresses wage rates while it provides profit bonanzas. Moreover, when government makes expansion well-nigh impossible business may struggle to remain profitable by computerizing operations and releasing unneeded labor. The phenomenal advances of computer-assist-ed technology using much high-skilled and highly educated labor have contributed to the income disparity.

A demographic change, finally, may have contributed its share to the growing inequality in household incomes. As labor incomes decline many wives and mothers feel compelled to enter the labor market and supplement the family income. Many are well-educated and highly-skilled. Being married to well-educated professional men, they form households with very high incomes. They have increased the income gap between affluent Americans and all others.

No matter how we may look at the growing disparity of incomes, it confirms a well-known economic principle: political intervention in economic life is bound to make matters worse. It usually brings about the very opposite of what the legislators and regulators had in mind. In order to attain greater economic and social equality they burden the more affluent members of society. But the extractions consume productive capital, which reduces labor productivity and wage rates while it raises interest rates and the returns on capital owned by the rich. Both effects increase the inequality.

Any policy that seeks to deny or defy human nature is bound to disappoint. Designed to reduce or even eradicate economic equality, it must come to grief at the vast differences in human nature. Some individuals are highly productive, rendering extraordinary services to their fellow-men as scientists, inventors, poets, com posers, entertainers, athletes, and entrepreneurs; others may be unable or unwilling to render valuable services. In economic terms, some have million-dollar productivity, others have little or none at all. In a competitive economic system, they all tend to earn incomes directly proportionate to the value of their services. Government may forcibly interfere with this process through tax-and-spend “redistribution,” but human nature tends to adjust to the force. Making its appearance in the laws and principles of the market, it enlarges the income disparity in order to restore the natural inequality. In recent years, the growing disparity has become another example of the supremacy of economic principle over political force.

 

Hans F. Sennholz

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September 1996

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