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Fixing Income Inequality

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Solutions From the World's Last Fundamentalist Progressive Libertarian

It's clear that somehow we've developed an economy in America that is prone to concentration of income and wealth among corporations and the rich.   Objective measures show that the rich are getting richer, the middle class is losing ground, and poor people are doing worse.   This is the biggest issue facing the US economy today.   Furthermore, this concentration results from public policies that have become so much a part of American institutions that they are taken for granted by citizens resigned to a status quo they have always known.

Poor people are a problem, and they are not going away just because we ignore them.   Most progressive economic talking points focus upon poverty in one way or another.   These include a statutory minimum wage and safety-net programs like welfare, food stamps, unemployment compensation, Medicare, Medicaid, and even key features of the ACA.   A little further afield, but still closely related, are efforts to provide equal opportunity for women and minorities, and to promote education for all citizens, especially the poor and disadvantaged.

Some of these programs have been successful, and all have done some good for some people.   The statutory minimum wage is among the more successful.   Even today, an increased minimum wage would benefit the majority of low-wage workers, would provide a boost for the Social Security trust fund, and would even contribute to a more balanced federal budget.   So in the absence of more fundamental solutions, I favor an increase in, and future indexing of, the statutory minimum wage.   Any program that benefits women, minorities, and the working poor can't be all bad, and would move us ever so slightly toward a less skewed concentration of income in America.

All good and well, but the fundamentals of the US economy are deeply flawed, and have never been effectively addressed by progressives.   Some people believe that a capitalistic, free-market economy necessarily brings with it an intrinsic tendency to concentrate wealth and therefore must be fine-tuned with regulation and encumbered with liberal or progressive programs to equalize for the natural tendency of a market economy.   And today we have a system that reflects this notion.   In such a system, it is indeed necessary to institutionalize safety-net programs, statutory minimum-wage requirements, and extensive systems of regulation to address the power of corporations.   These I consider to be flawed progressive solutions, and we can do better.

     First, let's examine what a free-labor market would look like from a microeconomics perspective.   Take a look at the first graph.   It illustrates the patterns of supply and demand at different intersections of price and quantity.   At a single point, supply and demand intersect with each other in equilibrium.   This illustrates the assumption that a free-labor market exists in America, and it is a fallacy.   But it makes a good starting point for understanding the economic problems in the labor market today.   A lot of conditions keep free-labor markets from being a reality, but I'll present two solutions that are clearly in the realm of public policy, and show one enormous benefit that would result from the restoration of a more balanced and free market.

Solution #1:   Stop subsidizing capital

The concentration of income and wealth we see around us was not an accident; it was the planned consequence of public policies promoted by wealth and business from the beginning.   You may have your own list, but here are examples from mine.   Federal land grants to settlers, ranchers, and railroads over the past 200 years have favored commercial interests over mostly Native American poor people.   Income-tax policy grants subsidies on income derived from capital investment at the expense of income derived from labor.   Federal, state, and local governments have lent their forces to the direct support of management at the expense of labor at times of conflict.   A private, for-profit, contract-prison industry has grown up among us at the expense of taxpayers and citizens.   The US military protects the interests of American multinational corporations all over the globe, at a public cost of several hundred billions of dollars.   Monetary policy subsidizes banks and other lenders by infusing them with cheap money at the expense of fixed-income investors and retirees.   Foreign humanitarian and military aid subsidizes domestic agribusiness and arms manufacturers, at the expense of taxpayers.   Income-tax policy favors the banking, construction, and real estate industries by subsidizing the cost of home ownership at the expense of other taxpayers.   Corporations are accorded the power to finance and influence elections and the formation of public policy in an increasing range of ways, at the expense of individuals' exercise of power at the ballot box.

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Concentrating wealth concentrates power, and that power is exercised by employers to maximize profits.   Reducing labor costs is a key goal of profit maximization, and can be achieved in several ways.   Paying as little as possible is a valid strategy, of course, especially in a free-labor market.   Minimum-wage employers pay a minimum wage because they can, not because they cannot afford to do otherwise.   In the absence of free and balanced labor markets, it becomes necessary to apply the progressive remedy of reasonable minimum wages to offset the power of the employer, and to protect those who fall into unemployment when they are laid off.   Centuries of subsidies for capital and business have empowered management with enormous resources at the expense of labor.

This principle is evident in the favorable treatment of investment capital.   Capital is obtained through the sale of equity, through borrowing, or from accumulated profits.   Equity capital is subsidized by tax limits on capital gains and qualified dividends; borrowing is subsidized by monetary policy and tax policy; and retained earnings are subsidized by an array of profit-friendly laws and regulation.   Once capital is ready to deploy within the business enterprise, additional subsidies are available.   These include everything from investment tax credits to accelerated depreciation allowance to enterprise-zone incentives.   In America we have come to adopt business investment as a national value, but I believe this is misguided; business corporations have proven to be perfectly capable taking care of themselves and making their investments pay off.

Voluntary business investment is directed toward one or more of the following goals:   (1) to produce something innovative that didn't exist before; (2) to expand productive capacity; and/or (3) to increase labor efficiency.   Only the first is likely to generate incremental employment.   Expanding capacity often cannibalizes competitors' operations and is usually more labor efficient than the operations it replaces.   Investments in labor efficiency by their nature reduce labor demand per unit of output.   Please understand that none of these things is bad; only the financial subsidies and incentives found in our public policies are bad.   And they are very bad, because capital investment is a substitute for labor employment, which is a true commodity at the low end, and is not generally subsidized.   This is one of the things that keeps the labor market in America from being a free market.

Now take a look at the second graph.   This one illustrates the pattern of supply and demand when it has been altered by capital subsidies.   Capital investment tends to reduce aggregate labor demand because of the efficiencies introduced by such projects as process automation and capacity scaling.   Reduced labor demand affects the equilibrium point by reducing both the price of labor and the quantity in demand.   In effect, reduced wages and unemployment are directly caused by capital-investment subsidies.   And the simple, obvious, and inescapable solution is to stop subsidizing capital investment!

Solution #2:   Stop taxing labor

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A look at the federal budget for a typical year shows that 40%-45% is funded by personal-income taxes, another 40%-45% is funded by payroll taxes, and the balance is funded by corporate-income taxes, ad valorem levies, and borrowing.   This mix of revenue harms the economy and damages the labor market beyond all recognition.

The miasma of penalties and incentives in the income-tax system is criminal.   Many are designed to affect the decisions we make, ranging from marriage and family through buying or renting our home, to political action and charitable donations.   To the extent that these provisions influence our decisions, they diminish our personal freedom.   And each feature of this cruel system generates its own winners and losers, eroding the efficiencies of free markets, adding friction with each complicating provision.   Worse, federal income taxes are lower on income from capital than on income from labor, due to favorable treatment of capital gains, qualified dividends, and even interest on certain classes of investments.

As bad as the income-tax system is, payroll taxes are even worse.   In a free market, the supply and demand of a commodity finds its equilibrium at a particular price and quantity, as shown in the first graph.   But there's no free market here.   Adding a tax to a commodity raises the price to a point along the demand curve that corresponds to a reduced quantity consumed.   Labor, especially the undifferentiated low-wage services, is indeed a commodity, and currently costs employers a federally-mandated premium of 13.85% for all lower-wage employees.

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Years ago I made a decision to commit to a life of business management. Kids do the dumbest things! After thirty five years as a small business consultant, CFO, and university educator specializing in quantitative business and economic (more...)

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