Income Inequality in the US

“In policy, as well as in morality, the grand secret is not to constrain the actions, but to awaken the inclinations of mankind”

Economics is mostly about expectations. The more confidence people have in the potential of the country’s performance, the more the entrepreneurial spirit will be incentivized.

Governments have lost credibility. Fiscal deficits and financial crises share the same cause as that of income inequality. The economic system favors those at the top, creating a winner-takes-all-society. The system lacks the controls to level the playing field. The rules of the game are unfair.

Income inequality in the United States has progressively grown over the past three decades. According to data from the Congressional Budget Office (CBO), after-tax income for the highest-income households grew more than it did for any other group. The CBO found that, between 1979 and 2007, income grew 275 percent for the top 1 percent of households, 65 percent for the next 19 percent, just under 40 percent for the next 60 percent, and 18 percent for the bottom 20 percent.

Income inequality is threatening the very national character of this country and jeopardizing America’s hegemony and status in the world. In order to solve it, the government must build a new social contract where people actually have equal opportunities to succeed, and the only way to do it is by recovering the confidence of the people.

I believe greed is part of the very human nature. The second law of thermodynamics, entropy, tells us how natural systems in the universe, tend to disorder and chaos. Social systems follow the same pattern. Therefore, we need the incentives and the rules to maintain an equilibrium or to redirect the natural inclinations of human beings. As the economist John Baptiste Say stated in late 1800’s, “In policy, as well as in morality, the grand secret is not to constrain the actions, but to awaken the inclinations of mankind”.

That’s why I disagree with most of the IMF’s recommendations. They suggest to cut spending and consumption in order to reduce the budget deficit, but they have no problem in transferring billions of dollars to banks, who were the main responsible of the crisis, not only in America, but also in Greece and other countries of the EU.

A new economic model would need to create the right incentives that reduce the vulnerability of the economic system. It would take into account the new economic challenges we’re facing and the new realities in a globalized world, such as income inequality and the importance of the middle class. The recommendations contained here are mostly formulated taking into consideration a demand approach, in an attempt to protect consumers as opposed to the measures taken recently by the government to bailout banks:

First, the government should accompany this process proactively, and not only as an observer of a free market economy. Capitalism should continue to exist, but more regulation will be needed to ensure a better distribution of income. Regulation, for example, in the financial industry.

Second, social programs, such as social security and unemployment insurance, are desirable and necessary to create a safety net for lower-income households, mostly when the country is starting to recover from a deep crisis.

Third, government revenues will have to come in the form of taxes. There is no other way. A modern society cannot function without significant taxes. Politicians who consistently say they will cut taxes, they’re lying. When you cut taxes today, you have to increase it tomorrow. People know it and that’s why they smooth consumption through time and spend less today. Remember, is all about expectations. On the other hand, taxes should be progressive and increase as household’s income increases.

Fourth, government revenues should be used partly to ensure the continuity of social programs and partly to reduce the fiscal deficit. This will also contribute to recover the confidence of the citizens on the economy. Government spending should also be aimed at funding education to lower-income individuals through scholarships. Better educated people will boost the emergence of a wave of entrepreneurs.

Fifth, in the long run, resources should be applied to improve the education system and to increase research on science and technology. Innovation is key to adapt to new global challenges we’re facing and the US has historically proved to be at the top of innovation.

In conclusion, an old view of the economy in the United States has failed to explain current economic realities and, more importantly, few people and interest groups have taken advantage of this scenario. The deterioration in such economic indicators –inequality and the middle class to population ratio– has undesirable social consequences. The widening in the income gap and the shrinkage of the middle class in the US is causing a poor economic performance and may eventually spur social instability.