Why There is Wealth Inequality

There is a lot of talk about fairness and income inequality in the media as they try to make wealth redistribution policies more palatable to the public. Don’t get me wrong, I do not have a problem with taking more taxes from Warren Buffet or Bill Gates. The problem starts when they start taking money away from me and I do not believe this is helping anything! When they take money away from me, I have to cut expenses elsewhere. In my case I cut my savings rate. The extra money taken from my paycheck reduces my retirement money and more dependent on social security. It is that simple!

As a country we have long since passed the point where we have a balance between spending and saving. Our defined pension plans and 401K plans are woefully underfunded and our social security system is a sham. The problem with the middle class is not income inequality or fairness. We are stupid! We make dumb decisions with our money and how we save. You hear this all the time if you listen to Dave Ramsey. Here is a quote from a John Goodman post, Why There is Wealth Inequality.

The greatest inequality of wealth holdings is among the elderly and the primary reason for that inequality is the different saving rates of people when they are young. Here is Noah Smith:

If you do the math, you discover that in the long run, income levels and initial wealth…are not the main determinants of wealth. They are dwarfed by…savings rates and rates of return. The most potent way to get more wealth to the poor and middle-class is to get these people to save more of their income, and to invest in assets with higher average rates of return.

Pointer from Arnold Kling.

Unfortunately the key idea we get from Keynesian economics is that increased spending is good for the economy and deficits are not important. Although I am skeptical that this plan ever worked, we can see that since 2000 this plan has definitely not worked. Here is the chart I created a couple months ago to show that relationship. For those unfamiliar with Mitchell’s Golden Rule, “the private sector should grow faster than the government”. I still prefer the stronger form which states the private sector should grow faster than the growth in government debt if we want to grow out of our mess. As a country if our economic policies are working, the green line would be lower than both the red and blue lines. If we look at the country as an individual investor, we need a greater return on our investment and this dependence on debt is not working!