Tax changes won't fix inequality

By DAVID MOON, Moon Capital Management, LLC
December 15, 2013

There is a difference between income and wealth. They are not the same thing. As counterintuitive as it sounds, seldom does high income result in wealth. Wealth almost always results from the deployment of capital, not the accumulation of excess income.

Wealth attaches to people who own things. As Robert Kiyosaki wrote in “Rich Dad, Poor Dad,” poor people work for money; rich people have their money work for them.

Income is, oversimplified, the cash flow into a person’s checking account each year. Wealth is the net amount of all of a person’s valuable stuff.

By definition, there will always be a difference in the wealth of the people in the top and bottom economic rungs. In a capital-based society, that gap will always increase. Capital is a beneficiary of the power of compounding, increasing the monetary benefit of owning things.

As long as our economy is based on voluntary application of the factors of production, taxes are ineffective as a wealth equalizer. Is it any more effective at redistributing income?

To reverse income disparity seems easy. Just take some money from one group and give it to another. Then keep doing it. But that not only hasn’t worked for 40 years, but the more we try to redistribute income, the larger the disparity has become.

Beginning in 1948 (when the US began accumulating reliable income data,) percentage increases in income were relatively equal across income groups. The top ten percent of wage earners has obviously always earned significantly more than the bottom ten percent or even the bottom 90 percent, but the annual percentage increases in incomes across groups remained relatively stable for 25 years.

Applying the same percentage increase to a big number and a small number causes the absolute difference to increase, but it does so at a linear rate.

Beginning about 1972, however, the difference began to exponentially accelerate, ironically almost immediately following the passage and implementation of a series of programs aimed at income distribution: the New Deal.

As we have transferred more income to the lowest wage earners, the gap between the top group and everyone else has grown faster.

A recent report from the Center on Budget and Policy Priorities indicates that by 2010, the bottom ten percent of income earners paid negative 9.2 percent of all federal income taxes.
That is, this group of wage earners now receives refundable tax credits in excess of the amount of federal income tax otherwise owed.

For 40 years we have intentionally tried to correct income inequality by simply redistributing income—and it was during this period that those inequalities increased at the fastest rate in our country’s modern history.

Tax policy provided no correction in the increase in income inequality, and attempts to redistribute income through tax policy have actually corresponded with the difference growing wider.

We don’t know what causes these inequalities, but we certainly know what doesn’t reverse it.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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