America's Income Inequality Problem

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President Barack Obama campaigned, in part, on a promise of raising taxes on the rich and giving breaks to the poor and middle class.  During that campaign, according to Investor's Business Daily,1 Obama said that there had been a "huge shift in terms of resources to the wealthiest, and the vast majority of Americans were taking home less and less.  Their incomes, their wages have flat-lined at a time when the costs of everything have gone up, and we've actually become a more productive society."

Statements like this, along with a flood of rhetoric, have gone a long way toward convincing people that there is a huge problem of income inequality in this country that needs fixing.  The rich are too rich, this line of argument claims, while the poor are too poor, and the middle class simply isn't reaping the benefits of all its efforts.  According to this line of thinking, while the nation as a whole has enjoyed an unprecedented increase in productivity and wealth creation, the middle class has largely been left out.  People are working harder and getting less for their efforts, while CEOs are raking in seven-digit bonuses.  The consensus seems to be: It's just not fair.

To get a clearer picture of what's going on, let's start with some basics.

We live in a capitalist free-market economy.  That economic system has made us the richest society in human history.  It means that anyone can get rich and anyone can lose all they've invested.  It also means that people who make better decisions, have more talent, and work harder will get ahead.  It means that there are winners and losers. 

When one person wins big — say someone who develops a piece of software like Microsoft's operating system — a lot of people win, because the company employs people and thereby spreads the wealth around.  People who are smart enough to join up early with a winning organization typically become stockholders, and they, too, frequently become rich.  Employees who join up later reap some of the benefits, but their share will naturally be smaller.  In essence, the greater the risk, the greater the reward

For all except the die-hard socialists, the complaint isn't so much about unequal rewards, but about the fact that the distribution of rewards seems to have shifted over recent decades.  As pointed out by Brian Wesbury and Robert Stein in a recent Monday Morning Outlook2 column, productivity has grown by about 2 percent per year for the past three decades...

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