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American problems: income inequality and financial speculation

2011-12-13

New data on levels of income inequality have become available, covering 2009 with pre-tax data from the IRS.  Inequality has declined somewhat and the average income of the top one percent has fallen.  From 23 percent of all income in 2007, the top one percent has gone down to 17 percent of all income, and average income has fallen over 40%, from 1.4 million dollars a year to just under one million.

Data from the last 100 years (well, since 1913) have shown some interesting correlations.  Income inequality peaks just before a stock market crash; in 1928, the figure stood at an all time high of 24%.  The same thing occurred before the latest episode, now termed the Great Recession by some, and before the previous dip, in 2001, after the election of President Bush.

More importantly, in 1980, income inequality was less: the top 1% took home just 10% of all income.

The principle to be drawn from this correlation is that the top 1% depend on the stock market for most of their income, and their disproportionately high incomes are derived from economic booms reflected in stock market prices.  At the same time, the top 1% lose big when the stock market drops.  This means that the top 1% are, by definition, not actually doing any work to obtain most of their income.  They are simply buying and holding stocks and selling them when they appreciate.

What is more, a proportion of these high income earners are putting money into derivatives and other instruments that promise higher returns (and are more risky.)  The uncontrolled trade in financial derivatives was a cause of the 1929 crash, and probably also of the 2007 crash.  At the same time, uncontrolled trading in securitized mortgages was another cause of the 2007 crash.

We can see that higher inequality ratios are directly related to the practice of taking one’s money and investing it in risky financial instruments rather than putting it in a bank or buying “safe” instruments such as Treasury notes.

The ideal practice for a country with a really level playing field would be to prohibit the use of complex and risky financial instruments that lead to economic turmoil when wide swings in value occur.  Money should be deposited in a bank or with the Treasury.  Banks should then be responsible for financing construction, startups of new businesses, and other lending activities.  Their profits should be regulated and they should be insured so that they can take reasonable risks, like investing in companies that have new ideas.  Furthermore, tax policy should be directed towards a lowering of the inequality ratio when it is above ten percent, as it was in 1980, by the use of really progressive overall tax rates (instead of rates that leave Warren Buffet paying a smaller percentage of his income in taxes than his secretary.)  There is really no excuse for not charging enough in taxes to cover the entire government budget; a federal budget deficit is unnecessary except in the midst of severe recessions.  In good economic times, the federal budget should show at least a small surplus.

It’s not a sin to have a lot of money, nor is it a sin to live off the interest earned by investing that money.  It is immoral to try to get high returns by taking excessive risks, particularly with “leverage”, thereby putting the entire economy at risk.  It is also wrong not to pay one’s fair share of the expenses of government, from the roads you drive on to the care of the indigent.

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