Friday, May 12, 2006


Problem No. 1: Income Disparity

Since the Reagan administration there has been a growing gap between the income of the very rich and the rest of the population. For several years there have been articles on how the income of people in the top fifth (i.e. those making over $85,000 a year or so) keeps increasing with the implication that they are the rich. The truth is actually quite different. According to a New York Times article of June, 2005 income of those in the top 0.1% has been increasing dramatically, but not the icnome of those below. The diagram below (redrawn from that article) shows that the top 0.1% earn 10% of the total income which means that the average income of the top 0.1% is more than 100 times the average income of the 99.9% of the population (which includes not only the poor but also many wealthy people in the top 1% of the income range but not in the top 0.1%). Even more worrisome is the time trend that shows the reversal of the Roosevelt social policies by the Reagan administration.

According to the same NY Times article the top 400 taxpayers reported an income of over $87 million each! The New York Times has revisited the issue this year adding that people in the $100,000 to $200,000 range are going to be hit the worst by the Alternative Minimum Tax next year.

If we look at past history, countries with a few super-rich, a lot of poor, and a small or struggling middle class have not fared that well. Huge discrepancies in income lead to alienation and leave countries vulnerable to upheaval. Think of tsarist Russia and Shah's Iran. When things get very bad and there is a change, the change need not be for the better. Moderate reforms work out only before things reach a crisis. I do not claim that we are anywhere near the situation in Russia or Iran but if the current trend continues we may reach such a state within a generation.

Even though the risk of a major socio-political upheaval may be remote there is a more iminent danger. When income is accumulated by the super rich it is not likely to be spent in consumer goods but rather in exotic purchases. Money taken from the middle class is taken away from the consumer market. Look at the above diagram and see how the last accumulation of wealth preceded the Great Depression.

The following simple examples illustrates how big income inequalities affect people. Think of a company with 1000 employees and a boss whose pay is 10 times the average of the 1000 workers. If his pay was made equal to the average and the difference passed to the rest of the employees it will result to an average 1% raise for each one, not a big deal. However, if his pay was 1000 times the average such a redistribution would result in an average 100% raise for the rest!

I had made several trips to Japan in the early 1990's and I found out that the pay of the CEOs of large companies (over 10,000 employees) was 10-20 times that of the lowest paid worker. Similar figures had been reported in magazine articles. In American companies the same ratio was well over 100! Some people argued then that Japanese executives received more perks than American executives but that will not change the ratio much because most employees of Japanese companies also receive more perks than most American workers. The case of Japan shows that a capitalist economy can do quite well without extreme inequalities in pay. (I will get back to company matters in future postings.)

The disparity seems to be getting worse. According to the press the recent tax cuts approved by Congress benefit mostly the super-rich. According to Newsday of May 12, 2006 a person earning $50,000 a year gets a tax cut of $47 but a person making $1 million a year gets a tax cut of $42,000. That's more than 890 times larger even though the income ratio is only 20! Did anybody say something about progressive taxes?

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