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Rich Getting Richer, ever wonder why?

Discussion in 'Tilted Philosophy, Politics, and Economics' started by Aceventura, Sep 7, 2011.

  1. Aceventura

    Aceventura Slightly Tilted

    North Carolina
    I enjoy playing with numbers and I often do for no real reason. However the issue comes up frequently about the rich getting richer. In my opinion it has turned into a cliche or is a part of a populist political agenda to get votes. Sometimes I ask the question - is it true and why is it true if it is? It is very easy for a person with a high income to waste the income on perishable/disposable/depreciating items and have nothing to show for it and gain no real improvement in the quality of life. There is something else other than income if the rich actually get richer.

    Two people, person A and person B, both employed and both have the opportunity to contribute to a 401(k). Person A is in the top 35% tax bracket, person B is in the 15% tax bracket. For every $1 person A puts into his 401(k) he saves $.35 in tax - for person B it is $.15. Person A has more than 2x incentive from a tax savings point of view to put money into a 401(k). Let's assume person A contributes $10,000 per year and person B contributes $5,000 and introduce person C who contributes $0. They earn 8% per year for 10 years - what are the results:

    Person A - Invested $65,000 net of tax savings and has an account worth - $156,454.
    Person B - Invested $42,500 net of tax savings and has an account worth - $78,227.
    Person C - Invested $0 and has an account worth $0.

    For person A, he invested an additional $24,500 compared to person B and has an additional $78,227 in account value over 10 years. That is more than a 200% return on the money.

    Why does the government give person A more than a 2x incentive to save?
    If person C depended on a traditional pension and social security, does the government realize that C will have nothing to pass on to children compared to person A who has a real account with real money that can be passed on giving his children/grandchildren a head start in life?
    Why does the government give person A the means to get more than a 20% annual return on the difference in investment compared to person B?
    Does the government know that if all they do is raise the tax rate on person A, they actually give his a bigger incentive to invest in a tax shelter like a 401(k) compared to others like person B?
    Does the government realize that due to the incentive they created for person A that Person A may have otherwise have spent all thier money and accumulate no real wealth?
    Does the government know there are 100's of examples like this in the tax code?

    When I think about things like this, to me the answers are clear. We should have a tax code that treats everyone the same. What is the true argument for making the tax code more progressive, with more and more tax gimmicks and perverse incentives that disproportionally favor some above others?
  2. Baraka_Guru

    Baraka_Guru Möderätor Staff Member

    The rich get richer, generally, because it's easier to make money with money rather than labour.

    I'm not sure if switching over to a flat tax system will do anything to help poor people get richer. Is that what you're implying?

    Do you think that a flax tax system will encourage rich people to spend more? Do you think that taxes are such a high factor in the money habits of the rich? Do you think lower taxes on the rich will fundamentally change the saving mentality of the rich?

    Look at Eastern Europe, which is distinguished, more or less, as a geographic concentration of flat tax systems. Whether it's by coincidence or by other factors, economic inequality in these nations tends to be much lower than in places like the U.S., China, much of South America, and parts of Africa. Though there are anomalies: Russia has a flat tax and fairly high economic inequality, while Canada has a highly progressive tax system and has relatively low economic inequality. Also, compared to its eastern counterpart, much of Western Europe has a similarly low economic inequality despite progressive tax systems.

    So I'm not sure what your main point is: Are you suggesting that a flat tax system will be better for the economy? Do you have evidence of this? Is Eastern Europe thriving because of a flat tax system, or are they merely benefiting from stability (i.e. a progressive tax system would be devastating as an alternative)?

    Or are you merely stating that a flat tax system is a kind of social engineering that will prevent rich people from getting so rich?

    Is it the tax system that is most to blame for economic inequality?

    What's your central argument in support for a flat tax system?
  3. Aceventura

    Aceventura Slightly Tilted

    North Carolina
    The reason it may be easier to make money with money is because of systems as described above that allow some people to get extraordinary returns on investment compared to others.

    In the case of US 401(k)'s perhaps a better solution would be not giving people a tax incentive, period. Or, perhaps giving people the same incentive regardless of the amount invested or their marginal tax rate. Even the playing field. With thought there are many ways, other than flat tax systems, that can lead to tax neutrality.


    We know what our disagreement is. I believe innovation or it is the supply side first that leads to real wealth creation. I think you believe it is demand.

    On the margins, yes. In absolute terms, no. For example as I decide how to pay for my son's college education, tax issues factor into my decision. However, at the end of the day, he is going to go to college.

    Again, see the above. Another example, if a tax sheltered annuity means more income in retirement, net the costs, rich people will use them. Take away the tax incentive for a vehicle like this and they go away.

    I support a flat tax system but above that I support a fair tax system. I suspect cultural differences in various countries has as much to do with wealth disparity as anything else. I think tax policy is the simplest most direct way to correct wealth disparity. In the US, our tax policy adds to wealth disparity rather than minimizing it. Either way I prefer government to be neutral.

    I just did a little exercise to illustrate how tax incentives can lead to wealth disparity. The example is overly simplified, but illustrates how looking a little deeper into the cliche of the rich getting richer may lead to more practical solutions rather than the common refrain of simply raising tax rates.
    • Like Like x 1
  4. Baraka_Guru

    Baraka_Guru Möderätor Staff Member

    But, ace, I think the biggest thing you've demonstrated with the example is that the richest people (income of ~$380,000+) save more on tax when they invest more of their expansive wealth and non-rich people (~ $8,500 – $34,500) save relatively less on tax when they invest the same amount.

    However, you haven't taken into account how someone making $34,500 can easily contribute $5,000 per year to a 401(k). That's nearly 15% of their income. (That's also the best-case scenario.) I'm not saying it's impossible, but I can only assume it's a world easier for someone making $380,000 to contribute less than 3% of their income to a 401(k). (That's a worst-case scenario.)

    That is more interesting to me, not the tax benefit. This is why the poor have a difficult time retiring and usually depend on social security. Their incomes are too low for adequate financial planning.

    But I get the tax incentive. The more money you have, the less of it, as a percentage, you need to spend—so this often means more saving/investing. Greater incentives encourage more investment, which is what government wants. I'm assuming the incentive only applies for domestic investments, right?

    I don't see this as a tax issue so much as a income issue. As someone who fits into the category of Person C, I know that a major factor is income, not how much tax I pay.
  5. dippin Getting Tilted

    To use tax deductions on 401k and how some people don't even have enough money for a 401ks as an argument for making the tax code less progressive is about one of the most bizarre things I've ever seen. So because the richest person "saves" more through tax deductions, that is the reason why his taxes should be lower?

    As for why the income tax should be progressive, there are 3 reasons:

    - Income taxes are one of the few taxes that are progressive, and most other taxes are actually regressive. Overall, counting all taxes, the American tax system is very, very weakly progressive, and the share of total taxes people pay is almost equal of the share of total income people have. If the federal income tax wasn't progressive, overall taxes would be regressive.
    - Inequality has significant intergenerational effects. Even if original income disparities originate in differences in merit, following generations will start from different points. Some inequality is tolerable. Extreme inequality leads to a virtual caste system. A regressive tax system would speed up, instead of slow down, that process.
    - And finally, and perhaps most importantly, given how reluctant people are to talk about this: the rich benefit more from the American state than the poor. The fantasy that the American state is somehow a great redistributing tool from the rich to the poor and where welfare is a significant expense of the government is just that.

    Also, I find the obsession with income taxes to be a bit disingenuous. Federal income taxes are responsible for less than half of the federal tax receipts. The right wing obsession with the flat tax and with the "51%" who don't pay income taxes willingly ignores all the other taxes that eliminates the progressive element of income taxes almost entirely.
    • Like Like x 2
  6. ASU2003

    ASU2003 Very Tilted

    Where ever I roam
    I'm not sure those are 'the rich' that the people on the left are talking about.

    I'm thinking it is more:
    rich = businessman, banker, management, land/property owner
    poor = worker, consumer, unemployed, retiree

    The rich have a product or service that people demand. And they are able to increase their prices and raise fees if the have to..

    The poor have to pay whatever the price is to play in the game.


    On a side note, I would be interested in someone doing an actual study on 401k returns across the nation. What is the real average return rate?
  7. Derwood

    Derwood Slightly Tilted

    Columbus, OH
    Part time WalMart and McDonald's workers don't have 401(k)'s
  8. Baraka_Guru

    Baraka_Guru Möderätor Staff Member

    Well, that's no wonder, Derwood. Those are just transitional jobs held mainly by students and those between "real work." Right?
  9. Derwood

    Derwood Slightly Tilted

    Columbus, OH
    They are lazy "moochers", who are sucking the life blood out of the "producers".

  10. Baraka_Guru

    Baraka_Guru Möderätor Staff Member

    They should at least be paying federal income tax. All of them.
    • Like Like x 1
  11. Derwood

    Derwood Slightly Tilted

    Columbus, OH
    Which isn't a tax increase in any way, just so we're clear
  12. Aceventura

    Aceventura Slightly Tilted

    North Carolina
    A rich person can be rich now and poor later based on their spending habits. My point is that a system is in place where you give that rich person such a big incentive to do the right thing (maximize savings) that person is rich in the moment but in fact gets richer compared to everyone else.

    Person A can have a financial planner say do X and if the person does X, without any real though or effort and they solidify their wealth and begins to create generational wealth that can be passed on. Person B simply does not have the same incentive to do X and they do not have the opportunity to get the same level of ROI. Person B has to do more than person A to get the same type of returns because of the tax system. A favorite, Buffet, gets richer without trying very hard while his secretary does not have the same opportunity. Note - Buffet is considered a financial genius because he was consistently able to generate 20% annual returns for his company. Buffet is typically a phone call away from a 20% annual return deal given his current circumstance, status and the tax code. The irony is that the higher the marginal tax rates are the better he can do relatively speaking given our current system. I want everyone to have the exact same opportunity. My preference of a flat tax rate would do that - and there are other ways to get that done.

    The main point is to not put person B at such a large disadvantage relative to a rich person. Person A with a small additional investment over a 10 year period can double his net worth in my example compared to person B. Again, why do rich people get richer? Then we have person C who may not even afford to contribute to a 401(k), that person ends up with nothing. Again, why do rich people get richer? I think the answer is clear. Tax rates are less important than a fair tax system, in my opinion.

    Every employed person has a bout 12% of their income taken off the top for social security (employer and employee contributions) - perhaps for poor people we could reduce that to 6% and have 6% go into a account that they own. In this scenario the gap between the rich and working poor would get smaller.

    Regardless of income an incentive to do something has an impact. I believe people are rational. If I sacrifice a percentage of my income today and get 100% of it back in the future - I may or may not act. If the same is true and I get 200% back, I am more likely to act. If the same is true and I get 1,000%, I am almost certain to act.

    In the case of a state lottery, where the probability of a return of the $1 is close to zero, millions of poor people invest in lottery tickets everyday, this does not appear to be rational but given the potential payout they are willing to sacrifice their income for that future return because of the incentive. Poor people have a bigger incentive to buy lottery tickets and a small incentive to save so billions of dollars from poor people feed state lotteries at the expense of savings. And given the probabilities of success it contributes to the rich getting richer relative to the poor. Again that is the question, if the rich get richer, why?

    Also, addressing your question, incentive knows no borders. We see it all the time where capital flows to where the best incentives are given relative to other factors.
    --- merged: Sep 9, 2011 6:43 PM ---
    I think the "poor" as you describe it, underestimates or is ignorant of their value in the market. A worker earning $25,000 may be worth $100,000 to the employer. The employer has every incentive to make sure that employee is ignorant of their value. If that worker knew what his value was and put it on the market to the highest bidder, he may not get $100,000 but he could easily get more than $25,000. As a person in the business to business market, that give and take is my life. My customer wants my service at the lowest price and I want the highest price. I have to know what the market value of my services are or I get screwed or lose business. "Poor" people need to have the same attitude. Again if rich people are getting richer, why? Perhaps another answer is - attitude.


    Depends on investment options and the mix of investments selected. If a person did a 50/50 split between safe fixed income type investments and lets say the S&P 500 index, with dollar cost averaging over time can easily get 8%. Those who take less risk might get less and those who take more risk may get more. The key is time. Looking at 10/20/30 year periods the ups and downs even out and major trends become clear. With dollar cost averaging I doubt you could find any 10 year period where consistent investment in the S&P 500 index lost money, even including the Depression in the 1930's.
    • Like Like x 1
  13. dippin Getting Tilted

    So people who have the means to save and invest end up better off in the long run than people who can't save and invest? And that disparity is compounded by tax savings? Indicating that at least some inequality comes not from differences in merit, but differences in the initial allocation of resources? I think that is a point that many people in favor of redistribution try to make.

    How this in any way speaks for flat or "fair" taxes is beyond me.

    As for social security and transforming it into a savings account: I think pretty much everyone thinks that setting social security contributions aside and investing them will yield better returns than keeping the current pay as you go system. The point about that is, and always has been, that changing from a pay as you go system to a savings account system is extremely expensive. If you divert 6% of the contributions into different accounts, you'd need to either divert a lot of money from other sources to cover paying those currently receiving social security, or cut the benefits of those currently retired. That is, of course, not to mention that most republican proposals for these private accounts have been pretty naked attempts at rent seeking by private financial institutions.

    But the basic point is simple: to divert money from social security contributions to private accounts, you'd need to find some 700 billion dollars a year to pay current retirees, or cut their benefits.
  14. Aceventura

    Aceventura Slightly Tilted

    North Carolina
    A you sure of that? Even if they don't they have IRA's and other tax favored ways of investing.

    Even a person who spends 30 years working part-time at Wal-Mart can retire with $1 million. Perhaps I will run some numbers in more detail - but adjusted the share price for Wal-Mart 1/1/1981 was $.25, 1/1/2011 it was $53.93. If over 30 years that part-time person purchased 18,542 shares they would have $1 million in Wal-Mart stock. If they bought it all on 1/1/81 it would have cost them $3,708. I am willing to bet if they simply had 5-10% of their income being invested in the stock, they could get their easily - even if they stayed at minimum wage the entire time. I bet the same would be true with McDonalds.

    And to add insult to injury - Wal-Mart pays a $1.46 dividend. With 18,542 shares that is $27,071.32 in dividend income every year. Imagine that part-time greeter at Wal-Mart that you feel sorry for may be making more than many people simply in dividends, know wonder they have such a big smile when I walk in! I give props to Wal-Mart, I started shopping with them about 5 years ago, and I love it. Another, thing about Wal-Mart compared to other stores they seem to be willing to hire every type of person - not just the American view of "good looking" people. Where do you shop and why? I bet it will tell us a bit about who you are.
    --- merged: Sep 9, 2011 7:09 PM ---
    You miss the point. Sure, a person with no income can not save.

    When I was a child my parents forced me to save. Every-time I even found a dime, they made me put 10% of it into a student savings account I had. My incentive was pretty clear. If you fail to see the importance of incentive you will fail to see the point I am making.

    Outside of the point I make. What is your theory on why rich people get richer?
    --- merged: Sep 9, 2011 7:12 PM ---
  15. dippin Getting Tilted

    Wait, so your solution for the poor not having enough to save and invest is to force them to save and invest? Because otherwise it seems to me that the reason the poor save less than the rich is pretty straightforward, incentives and all. Are you really suggesting, after providing your own example, that if you further reduce the taxes on the rich the poor will finally have enough incentive to invest and save? That, I don't know, not being poor anymore isn't enough of an incentive for that?
  16. Baraka_Guru

    Baraka_Guru Möderätor Staff Member

    People with lots of money get richer than people with little or no money because they use extra money to make more of it.

    I'm not sure how much simpler I can state that.

    I'm also not sure how that has anything to do with a flat-tax system and how that would help people with little or no money get richer like their richer counterparts.

    Are you merely stating how a flat-tax system would encourage rich people to spend more and save/invest less, thereby reducing economic disparity? I'm not sure that would even happen. I don't think anyone is.

    So to answer your question, ace: the rich get richer because they're rich. It doesn't matter how the taxes are organized. It's just a matter of degrees.

    It's difficult to invest $1 into something. It's much easier to invest $10,000, or even $100,000. Even if it were equally easy to invest each value, below are the returns compounded annually over ten years at 8%. The $1 investment will be reinforced by an annual deposit equaling an additional $1 daily saving, but the other investments will be a one-shot deal. Below are the results of the future values:

    $1 + $365 annually = $5,289.75
    $10,000 = $21,589.25
    $100,000 = $215,892.50

    The poor person with a dollar in their pocket and the discipline to save $1 each day ends up with over $5,000. Maybe enough for a nice investment somewhere else.
    The wealthier person ends up with more than 4 times the amount, possibly without even thinking about it for 10 years.
    The wealthiest person ends up with more than 40 times the amount, possibly having even forgotten making the investment in the first place.

    The wealthiest person could buy a modest house or an ostentatious car with their return.
    The wealthier person could buy a modest car or a lavish vacation with their return.
    The poor person could buy a used car, or be happy to be halfway towards the wealthier person's $10,000 principle, and maybe reevaluate things again in another 10 years.

    This is without any tax implications, but regardless.....

    Do you honestly wonder why the rich get richer? Or are you wondering why the rich have an easier time of it based on tax implications?

    Explain to me how a flat-tax "fair tax" system would change anything. Would it help this poor guy out? Or would it just help the rich guy out, as he wouldn't need to invest so much to have so much wealth?
    • Like Like x 1
  17. dippin Getting Tilted

    this whole discussion reminds me of that famous quote: "the beatings will continue until morale improves."
  18. ASU2003

    ASU2003 Very Tilted

    Where ever I roam
    I agree with that. But, the $25,000 worker (without a union or collective bargining) will only be able to request so much. If they ask for $40,000, the employer may choose to hire one of the 5-10 people who really need a job and would start on Monday. When 1 million people try to get a job at McDonald's and 940,000 are denied, what standing does the person lucky enough to get one of those jobs have for asking for more money?

    Bu they still are raising prices at McDonald's to cover higher gas and food prices...
  19. roachboy

    roachboy Very Tilted

    ace is one of those quaint unwitting aristotleans who thinks that social hierarchy is hard-wired. some animals are more equal than others.
    this quaint worldview is recoded into the magickal language of Motivation and Markets, who Has It and who Doesn't, it's still the same thing.
    for these people, the wealthy are wealthy because they're better.
    the rest of us should aspire to be better ourselves, follow the example of our aristocratic superiors.
    but we'll never get there.
    most people fail.
    they lack whatever the ultra-right substitutes for the old term virtue in aristotle.
    but it's no different.

    aristotle also opposed democracy.
  20. Baraka_Guru

    Baraka_Guru Möderätor Staff Member

    Amurica isn't a democracy! It's a REPUBLIC!