February 08, 2021
I have been dismissive of many of the folks, mostly progressives, who highlight wealth inequality as a measure of overall inequality. As most of us know, the richest people in the country have gotten a lot richer since the start of the pandemic. (Of course, the story isn’t quite as dramatic if we use February of 2020, before the hit from the pandemic, as the base of comparison.) As much as I am not a fan of rich people, this doesn’t especially trouble me.
I have never considered wealth a very good measure of inequality for several reasons.
- Wealth depends on financial asset values (e.g. stocks and bonds) that fluctuate wildly;
- Wealth can be a very bad measure of people’s economic circumstances;
- Wealth and social insurance are very direct substitutes.
There is also the very important issue of wealth translating into political power. I will get into that at the end of this essay.
The Fluctuating Value of Wealth
We have seen a sharp run-up in the price of stocks, bonds, and other financial assets in the pandemic, as the Federal Reserve Board pushed short-term interest rates to zero and also sought to lower long-term rates. Since the majority of these assets are held by the richest ten percent of households and close to half are held by the richest one percent, this meant there was a huge rise in wealth inequality. Should this bother us?
I would argue no, first because it is hard to disagree with the merits of the policy. The economy went into a steep recession last spring. Low interest rates have helped sustain demand in the economy since the onset of the pandemic. They have encouraged home buying and new construction. They also encouraged car buying. And millions of people are now saving thousands of dollars in interest payments each year because they were able to refinance their mortgage.
Lower rates also eased the financial situation of state and local governments, who were able to borrow at lower interest rates. They also likely led to somewhat more investment in both the public and private sectors. This is exactly the sort of increase in demand we needed in the economy.
Turning more directly to the wealth issue, Jeff Bezos and Elon Musk have more wealth now than would otherwise be the case, because the short-term interest rate is zero and the long-term rate on U.S. government bonds is around 1.0 percent. Let’s say that’s bad.
Suppose in a year or two, the economy has recovered and the interest rate on long-term bonds is up to something like 3.0 percent. Let’s imagine this knocks stock prices down by 20 percent and the price of bonds by even more. Is everyone happy now?
If wealth inequality is the big evil that we want to combat, then we should be celebrating a drop in the stock market that lessens inequality. Perhaps the opponents of inequality will be out there dancing in the street if the market plunges, but somehow I doubt it. Just as a logical matter, you don’t get to be upset about a rise in the stock market increasing inequality and not then be happy with a fall in the stock market reducing inequality.
For my part, I find it hard to get too upset about fluctuations in wealth that are likely to be temporary. There was not a fundamental change in the structure of the economy that caused the soaring wealth of the last ten months. In all probability, it is a temporary fluctuation that will be reversed. (I’m not making stock market predictions, so I’m not advising everyone to go short.)
Wealth as a Measure of Well-Being
If we stacked everyone in the world by wealth, going from richest to poorest, those at the very bottom would be recent graduates of Harvard business and medical school. I’m not kidding. Many of these people have borrowed hundreds of thousands of dollars to pay for their education. Most of them have few if any assets. This means that on net, they are hundreds of thousands of dollars in the hole.
Should we be concerned about these very poor people? Since they are likely to be earning well over $100,000 a year and quite possibly over $200,000 a year, as soon as they start work, it is hard to feel terribly sorry for them.
In fact, many of the poorest people by this wealth measure, both internationally and nationally, are recent graduates who have taken out student loans. While many of these recent grads will have trouble paying off their debts, most won’t.
The number of people with large negative wealth creates silly scenarios where we can say that Jeff Bezos or Elon Musk has more wealth than the bottom 40 percent (or whatever) of the world’s population. That is dramatic, but it also doesn’t mean much.
I probably have more wealth than the bottom 20 percent of the world’s population. That isn’t because of my great wealth, it is simply due to the fact that I have some positive wealth and the bottom 20 percent taken as a whole does not.
Even beyond these theatrics, there is still the problem that student debt makes for calculating well-being. Is a 30-year-old college grad with $20,000 in debt worse off than a high school grad with no debt? The college grad almost certainly has much better earnings prospects, with the difference swamping the $20,000 debt, but if we just looked at wealth, the high school grad is much better off.
But even besides this issue, there is also a more general problem of what counts as wealth. Forty years ago, most middle-income workers (especially men), had traditionally defined benefit pensions. These pensions could typically guarantee these workers a middle-class standard of living in retirement.
Traditional pensions have largely disappeared, especially in the private sector. This means that if a worker hopes to maintain a middle-class standard of living in retirement, they have to accumulate assets in a 401(k) or some other retirement account.
The money in a retirement account is included in standard calculations of wealth. Traditional pensions generally are not. (We can impute values for these pensions, but this is generally not done in most wealth calculations.) This leads to a story where we would say that a person with a 401(k) is much wealthier than a person with a traditional pension, even if they have no better prospects for retirement income.
Social Insurance as a Substitute for Wealth
The pension issue is only part of the story, social insurance more generally can be seen as a substitute for wealth. In addition to needing wealth to support income in retirement, we also might need wealth to deal with spells of unemployment, unexpected medical expenses, to pay for their children’s college and to buy a house. Some people also have aspirations of starting a business, which also requires some wealth.
The extent to which wealth is needed in each of these areas depends on how we structure our system of social supports. As noted, a good Social Security and pension system make it unnecessary to accumulate a substantial amount of wealth in retirement. In the case of unemployment, if we have a healthy system of unemployment insurance, most workers can be kept whole through stretches of unemployment.
It’s also worth noting that the wealth accumulated by middle-class people is primarily in their homes. This matters because this wealth is not easily accessible during spells of unemployment. Banks will be reluctant to issue a mortgage or home equity loan to someone who is unemployed. If an unemployed worker is able to borrow at all, they will pay a substantial interest premium on what would be viewed as a risky loan. They would generally be far better off with a strong system of unemployment insurance.
The same story applies to medical expenses. Bankruptcies due to medical expenses are virtually unheard of in Europe. The reason is these countries have national health insurance systems, which protect the vast majority of the population against major medical expenses.
The provision of a free or low-cost college education also makes it unnecessary to accumulate large amounts of money to pay for their children’s education. Even in a system with largely free public education, some people may still choose to pay the additional cost to send their kids to elite private schools. This sort of inequality in educational opportunity is unfortunate, but the better focus for public policy is ensuring that the public system is high quality and affordable.
In the United States, the vast majority of middle-class households are homeowners. While this does typically allow them to accumulate some wealth, the fact that ownership is a superior form of housing is largely due to our laws that effectively make renters a type of second-class citizen. In countries with stronger protections for renters, most notably Germany, homeownership rates are far lower.
There is nothing intrinsically desirable about homeownership. People want the security of tenure, so they know they can’t just be thrown out of their home on the whim of a landlord. They also want protection against unexpected jumps in rents. Both of these protections can be provided in a legal system that treats renters as full citizens. We actually see this to a limited extent in the United States, where some cities, most notably New York, provide strong rental protections. In these cases, we do see many solidly middle-class (and even affluent) people remain tenants for most of their life.
Beyond just making the point that strong systems of public support reduce the need for wealth in many areas, there is also the concrete matter that the instruments for accumulating wealth tend to divert large amounts of money to the financial sector. To just take the most obvious case, the annual fees on 401(k)s are often over 1.0 percent of the fund’s value. When the fees from managing individual funds within an account are added in, many people pay close to 2.0 percent of their fund’s value to the financial industry each year.
This could mean that a person earning $60,000 a year, who has managed to accumulate $100,000 in a 401(k), is paying $2,000 a year to the financial industry, or more than 3.0 percent of their income. This is money and resources that would be saved if the Social Security system were instead designed to provide them with an adequate retirement income. There is a similar story with wealth being accumulated to meet other needs, such as health care costs and college tuition.
Homeownership may actually be the worst in this respect. The costs associated with buying and then selling a home can easily exceed ten percent of the purchase price. These costs may not be a big deal for a person that stays in the same house for twenty or thirty years, but they are enormous for someone who only lives in a house for two or three years.
If someone buys a house for $300,000 and then sells it two years later for roughly the same price, they will likely pay over $30,000 in realtor commissions, closing costs on a mortgage, title searches and insurance, and other expenses. This comes to $15,000 a year, for expenses that would be completely unnecessary if they had remained a renter through this period. In a society that is structured to favor homeownership, it is understandable that most people would want to be homeowners, but we must recognize that homeownership is not inherently good, and it can be very costly for people who are not in a stable employment or family situation.
It is also worth noting that house prices do sometimes fall, as folks who lived through the collapse of the housing bubble should know well. The idea that the wealth people have in a house will inevitably increase is simply wrong.
Policies to support the accumulation of wealth for low- and middle-income families will almost always be seen as alternatives to policies for better systems of social support. It is clear that the wealth accumulation track is better for the financial industry. The track of stronger social supports is likely to be better for almost everyone else.
Okay, I left out the need for wealth to start a business. This is a case where it is hard to see a system of social supports providing an alternative, although the opportunity for stable employment and protection from unexpected medical expenses and the need to save for retirement and children’s education, should provide opportunities to accumulate some wealth. And, the vast majority of people will actually never try to start their own business.
The huge sums accumulated by the country’s wealthiest people have led many progressives to have dreams of the amount of social spending that could be supported with a wealth tax. As I have argued elsewhere, there are serious political, practical, and legal obstacles to implementing a wealth tax. But on this question, there is a more fundamental economic issue.
At the federal level, we need taxes to restrict consumption, not to literally pay the bills. As the Modern Monetary Theory crew reminds us, the government can print as much money as it wants. The limit is that if we create too much demand in the economy, it will lead to inflation. So, we tax to reduce consumption, by reducing the amount of money in people’s pockets.
If we think of the prospects of reducing consumption with a wealth tax, they don’t look very promising. Consider our latest round of incredibly rich people, like Elon Musk, Jeff Bezos, and Mark Zuckerberg, all of whom have over $100 billion in wealth. While I am sure these people all live very well, I doubt they spend substantially more on their own consumption in a year than your typical single-digit billionaire. There are only so many homes you can live in, cars you can drive, trips you take, etc.
This means that if we taxed away 10 percent, 20 percent, or even 50 percent of their wealth, it will have very little impact on their consumption. This means that it will not get us very far in freeing up resources for an expanded social welfare state. We will not be able to pay for Medicare for All or free college by taxing away these people’s wealth, we will have to focus on policies that reduce the consumption of a far larger group of people.
Wealth and Political Power
Many of the critics of extreme wealth point out the enormous political power that someone like the Koch brothers can wield because of their immense wealth. The point is well-taken. There can be no doubt that extreme wealth is horribly corrupting of the democratic process. This corruption takes place not only, or even primarily, through the political candidates whose campaigns they support, but through the academic institutions and think tanks they establish or support, and the media outlets they own. Many intellectually bankrupt ideas, like trickle-down economics, have survived and even thrived because deep-pocketed people were willing to support them in academia, policy circles, and the media.
But this diagnosis of the problem doesn’t mean that an attack on extreme wealth is the best solution. Suppose we cut the wealth of the richest 1,000 people in half. They would still be able to exercise a ridiculously outsize influence on the country’s politics.
The Koch brothers (or the surviving brother) with $25 billion would still have enough money to support all sorts of right-wing think tanks and issue groups. The same is true for the rest of this group. We don’t have a plausible path where we can hope to seriously limit their influence by reducing their wealth in any reasonable time-frame.
To my mind, a much more plausible route is to go in the opposite direction by increasing the voice of ordinary people. There are concrete steps that can be taken that go far here. The super-matches for campaign contributions that several cities have put in place and are part of the last Congress’s HR1 political rights bill are a great start. These proposals match small-dollar contributions by many multiples (HR1 puts the match at six to one) in exchange for candidates limiting their big-dollar contributions.
Seattle has gone a step further in giving its residents $75 “democracy vouchers” that can be donated to any candidate who agrees to limits on big-dollar contributions. The Seattle model can actually be taken a step further in providing tax credits for people to support journalism and creative work more generally. A modest tax credit applied nationwide, can provide an enormous amount of money to support creative work, including newspapers, radio, and television outlets, as well as think tanks and unaffiliated academics. This credit would ideally be put in place nationally but can be done at the state or even local level, as Seattle has done with its democracy voucher.
This will not allow for average people to outspend the billionaires, but it can ensure that they can have a serious voice in public debates. That is probably the best that we can hope for in the foreseeable future.
Big Wealth is a Big Distraction
To sum up, I would argue that the focus on the enormous fortunes of Elon Musk, Jeff Bezos, and others is an enormous distraction. It certainly is not good news to see the already incredibly rich get even richer, but wealth inequality should not be the main focus of progressives. The extent to which they actually drain resources from the economy is not well-measured by their wealth. And, we don’t have a plausible path for reining in their political power by reducing their wealth. The more promising path is by increasing the voice of everyone else.
 Bond prices move inversely with interest rates.
 Typically, the insurance company or brokerage house managing a 401(k) charges a fee just to hold your money. That averages around 1.0 percent. However, the individual funds in which people invest their money, such as a stock fund or a bond fund, also have fees. For index funds, these fees tend to be low, usually between 0.1-0.2 percent. However, some actively traded funds charge considerably higher fees, sometimes exceeding 1.0 percent.