Income Disparity and Sustained Economic Growth

Income disparity is again a front-page political issue. Credit Suisse projects that in two years the global 1 percent “... Will have more wealth than the remaining 99 percent of the people.” In the U.S., the top 1 percent earns a mean household annual income of $1,318,200. This is approximately 70 times the annual income of the average American worker.

'The 1 percent' now own approximately 36 percent of America’s wealth. Most telling, over the last decade the wealth of the top 1 percent earners has grown, while the bottom 80 percent’s wealth fell from approximately 20 percent of the U.S. economy to around 10 percent.

Wealth concentration restricts sustained economic growth

To appreciate how wealth concentration can blunt economic growth, think Czarist (or modern-day) Russia: A lot of poor people and a few wealthy families does not sustain economic growth. Recovery from the Great Depression provides similar insights. The path to economic recovery was not through enriching the rich. It was through enriching the middle class so they had the capital to start businesses and grow families.

Now consider our current economy: The inability of our economy to achieve sustained economic growth is tied to our middle class being mired in 15 years of no real income growth. Our economically-stagnant middle class is restricted in their ability to financially bootstrap and sustain businesses that have always been America’s lifeblood for job and economic growth.

The difference between wealth creation and economic capital growth

Nobel laureate Joseph Stiglitz (born and raised in Gary, Indiana) has focused his economic research on the question of how income inequity impacts an economy. His pioneering work identified a distinction between growing wealth and growing economic capital.

Today’s wealthy are increasing their wealth through public policy that enables them to borrow money to buy more assets and then pay low tax rates on capital gains earned from selling these assets. This is creating price inflation in assets symbolized by a $100 million New York City condo with Central Park views and the sale of a 1962 Ferrari 250 GTO for almost $35 million. The wealthy are investing in investments. They are not investing in job creation.

We also see this distinction between wealth creation and economic capital creation in corporate America. American corporations are flush with cash even with stagnant revenues. This is achieved through public policy that has enabled concentration of market power among a few competitors within a business segment. Airlines are an example: Fares and profits are up because of public policy that enabled consolidation of airline ownership that shifted pricing power to a few remaining airlines and away from the consumer. Think in terms of your cable, cell phone and electricity bills: You have limited or no choice, resulting in high bills. Corporate America, enabled through public policy that is bestowing upon them increased market powers, is growing profits by pushing down employment, wages and competition. The ramifications include a stock market setting record highs while the middle class consumer remains mired in zero real income growth.

Our country's path to sustained economic growth has historically been through the middle class investing in their small businesses and their families. The middle class uses their capital to start and run small businesses that generate job growth. They also generate jobs by investing in their families through home buying and from paying local taxes for services like schools and roads.

Stiglitz’s distinction between public policy that grows wealth versus public policy focused on growing economic capital defines the economic challenge facing our country. The economic evidence points to our public policy failing to support the middle class’ ability to create economic capital that enables economic and job growth. We are overfunding wealth creation and underfunding the creation of businesses, factories, city infrastructure, schools and similar economic capital assets that support sustained economic growth.

Five steps to sustained economic growth

The following are economics-driven public policy solutions that will restore middle class economic growth enabling economic capital creation. If implemented in tandem, they will economically restore the middle class and enable sustained economic growth.

1. 15 percent top income tax rate. What is good for the goose should be good for the gander. The 1 percent's wealth creation is enabled by a 15 percent maximum tax on dividends and capital gains. This same top tax rate applied to all business and wage income will accelerate economic capital generation and enable sustained economic growth.

2. Eliminate most deductions. A 15 percent top tax rate will underfund the government unless most deductions are eliminated. Our current tax code is a labyrinth of subsidies that distort economic decision-making. Eliminating special interest tax benefits, accelerated depreciation and investment tax credits will return economic decision-making to an investment’s or business’ core financial fundamentals. It will eliminate the economic nonsense where a cruise line company pays a 1 percent effective tax rate, a major corporation with billions in positive cash flow pays no taxes, or the most wealthy individuals transfer funds overseas to avoid taxes.

3. $15 minimum wage. Despite conservative protests against raising the minimum wage, because of a fear that it will reduce business competitiveness, the economics have shown that raising the minimum wage is an accelerated path to sparking sustained economic growth for American businesses. The bottom 20 percent of American workers make less than $12.50 per hour. At $15 per hour, they would still spend all they earn to maintain a standard of living. Their $15 per hour is cash that would immediately convert into new revenues for local businesses and increased local taxes for communities.

4. Eliminate payroll taxes. If we seek job creation and an increase in middle-class income, then why tax payroll? Eliminating these taxes will address business concerns over raising the minimum wage to $15. It also makes starting a factory in America more attractive by reducing labor costs since most factory jobs pay $15 or more per hour.

5. Tax pollution and landfill waste. If we eliminate payroll taxes, we need to raise taxes elsewhere to pay for Social Security and Medicare. Taxing pollution and landfill waste is a great solution. A higher tax on pollution and landfill waste will provide a strong economic signal in support of more efficient business operations and factory production. Increased efficiency is a huge competitive advantage for an economy. In addition, assuming a strong tax on pollution will reduce pollution, the economy will also economically gain from a potential $200+ billion reduction in health care costs that are tied to pollution.

Image credit: Flickr/Gawain Jones Photo

Bill Roth is an economist and the Founder of Earth 2017. He coaches business owners and leaders on proven best practices in pricing, marketing and operations that make money and create a positive difference. His book, The Secret Green Sauce, profiles business case studies of pioneering best practices that are proven to win customers and grow product revenues. Follow him on Twitter: @earth2017