The Driver of Wealth Inequality

by Vox 1 min read6th Feb 20196 comments


With regards to wealth inequality, the structure of the American machine as it currently operates appears to be broken.

Compounding interest, that process by which wealth grows over time, was once said by somebody somewhere to be the eighth wonder of the world, and well might it be.  However, differences in relative rates of compounding ability between those who are wealthy and those who are poor can result in a dangerously widening divide as time ticks onward. From the income perspective those who are wealthy, financially literate, and have the time/energy/experience to act gain significant competitive advantage in the compounding game through, among other perks, education, downside protection, tax mitigation, and the ability to pay for skill (lawyers, money managers, tax accountants) than those who are not financially literate. As just one example, with capital gains tax being at a much lower rate than salary tax you have those who derive the majority of their income from capital gains able to compound at a much faster rate than those who must cede a larger portion of their income to the government.  Just as $0.01 doubled each day will set you up with a little over $5mm by the end of the month, so that small difference in taxable income will, over time, compound to a very much larger sum.

On the costs side, those who are already wealthy pay a smaller percentage of their income in costs (food, living, healthcare) than those who are poor and already paying 30-50% of their income as rent and living paycheck to paycheck.  The price of a banana, a beer, or a visit to the dentist will not materially change commensurate with your wealth, and putting aside money for a nest egg in this high-percentage cost situation is significantly more difficult.

These add up to an incredibly inefficient system whereby the bounty from a surging economy is funneled upwards.  As their wealth proliferates, an already ludicrously wealthy subset of the population becomes steadily more so.

That said, it's important to point out that the structure isn't necessarily the fault of those who have been rewarded by its setup. Certainly, many wealthy individuals feel they have done their due diligence to properly understand the financial system, to hire the best accountants, lawyers, etc, and are only being compensated for shrewd decision making, back breaking, and risk taking. After being rewarded for such behavior, it becomes the smart thing to do; to grow and incubate the nest egg in offshore bank accounts instead of pouring that money back into the American economy like their middle and lower-class counterparts.  This is even more “common sense” if your field and your daily exposure is already in finance, in management, or in running a business.

In this age, as shareholders look for ever increasing revenue and income, corporations (whose gains flow to investors and financially savvy shareholders) must increase prices for those that consume their products while keeping costs down in the form of suppressed worker wages and even complete automation of those jobs where possible. This is additionally catalyzed by the development and deployment of AI in markets.  In today's American paradigm, it's easy to see that those who are already wealthy reap the majority of the economic reward, while those who are not bear the brunt of the economic costs.  In this system, savvy compounding drives the wedge ever deeper.  Hopefully there will be some way to address this divide before inequality tears our American dream apart.