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In the aftermath of the financial crisis of 2008, economic growth predictably slowed down in most industrialized countries. Many commentators on the political left have grasped onto this opportunity to point to the vast amount of income inequality which exists in the United States and reason that it played a part in causing the crash. This argument is typically paired with a proposal to raise taxes on the rich to balance out societal incomes. It is alleged that having government brutes step in order to play the role of Robin Hood is the best and most justified way to alleviate income inequality.
Presently, income inequality in America is at its highest peak in decades. In 2011, a study by the Congressional Budget Office concluded that after tax income grew by 275% for the top 1% of income earners between the years of 1979 and 2007. The top-fifth of the U.S. population saw a 10 percentage point increase in their share of total income in the same period while all other groups saw their share decrease by 2 to 3 percentage points. The data undoubtedly shows that income inequality has been increasing over the past few decades. New York Times columnist and economist Paul Krugman has latched onto the evidence and is suggesting that rising income inequality plays a part in causing recessions. Economist Joseph Stiglitz, who recently wrote the book “The Price of Inequality,” has argued that without a fair share of the national income, the middle class is unable to spend enough to keep aggregate demand elevated. Both economists see income inequality as a danger to the prosperity of a nation. Such a message is appealing to the greater public because it plays on their perceptions that the world is unfair. It almost seems intuitive to think that the rich posses too much wealth or that a prosperous society is one in which income is more equalized. Comfortableness in these beliefs paves the way for income redistribution efforts by the ever-scheming political class.
With income inequality a hot topic of debate going into the fifth year of the biggest economic downturn since the Great Depression, the question remains: does income inequality have a negative impact on society as Stiglitz and Krugman suggest? And is growing income inequality an inherit part of capitalism?
First and foremost, the idea of equality for man in physical attributes, mental fitness, and material security is essentially anti-human. The most appealing aspect of mankind is that every person varies from one another in a myriad of different ways. Some are better athletes, some are quicker studies, some have outer features that make them generally more attractive. It follows that some men and women will be more apt at producing or better attuned to the demands of the marketplace. They will have higher incomes by virtue of their own entrepreneurship or capacity to produce. So, in a sense, income inequality is a fact of the free market. But it is the possibility of inequality and the ability to achieve a higher income that makes capitalism work. Punishing those who excel at making consumers better off punishes the very market mechanism that leads to better living standards overall. In a free society, income inequality is not good or bad; it is part of the functioning order. Any attempt to make incomes more equal through state measures is unjustified plunder of the rightful earners of wealth.
But what of the inequality in income that exists in today’s state-corporatist economy? Did the 1% acquire its wealth solely through hard work? The answer is hardly in many cases. Though there are some innovative businessmen who became rich by providing new and better products, the sharp increase in income inequality over the past two decades is due to an economic phenomenon outside of normal market operations. Krugman and Stiglitz rightfully point out that the greatest periods of income inequality in the United States were the late 1920s and the period since the mid-1990s. What they fail to mention is that both these periods were not defined by capitalism run amok but by massive credit expansion. This expansion in credit, aided and abetted by the Federal Reserve’s loose money policy, is the real culprit behind vast income inequality. Economist George Reisman explains:
the new and additional funds created in credit expansion show up very soon in the financial markets, where they drive up the prices of securities, above all, common stocks. The owners of common stock are preponderantly wealthy individuals, who now find themselves the beneficiaries of substantial capital gains. These gains are the greater the larger and more prolonged the credit expansion is and the higher it drives the prices of shares. In the process of new and additional money pouring into the financial markets, investment bankers and stock speculators are in a position to reap especially great gains.
Since it's so important, the main point just made needs to be repeated: credit expansion creates an artificial economic inequality by showing up in the stock market and driving up stock prices.
Money acts as a medium of exchange but is not neutral in its effects on receivership. Those first receivers are able to bid up the price of goods before any other market participants. As the newly created money flows into the economy, the general price level rises to reflect the new volume of currency. In practice, credit expansion which brings about a reduction in interest rates also increases the amount of time businesses can go without making deductions for depreciation on their balance sheets as they purchase capital goods. Because investment tends to go toward durable goods during periods of credit expansion, there is less funds left over to devote to labor. Profits end up being recorded while wages sag behind. Since credit expansion and inflationary policy go hand in hand in distorting relative prices and must eventually come to an end, the bust that occurs reveals wasteful investment. Recession sets in shortly thereafter.
Printed money is not the same as accumulated savings which would otherwise fund sustainable lines of investment. And it is only through adding to the economy’s pool of real savings that productive capacity is able to increase in the long term. The wealthy have a higher propensity to save precisely because they have a higher income. It is through their savings that new business ventures are funded and the economy is able to grow without the faux profits from government-enabled credit expansion. This is why raising taxes on the rich is a backwards solution to income inequality. Taxation only funnels money out of the productive, private sector and into the public sector which focuses on spending to meet political ends rather than consumer satisfaction. All government spending boils down to wasted capital. The truth is that capital is always scarce; there is never enough of it.
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