The real culprit in income inequality

In his State of the Union address, the president is expected to discuss “income inequality” and the lack of “upward mobility” in America, but will again fail to address two major culprits behind much of the nation’s economic stress:  increasingly complex financial oversight and tax regulations.

If there were zero impediments to economic upward mobility, human nature dictates that some will succeed and some won’t.  Having the freedom to do so means that a successful economy will inevitably have disparate levels of income and wealth.  The obstructions that prevent access to opportunity are, therefore, what really matter.  Many legislators, and even the President, might agree…until they realize that they are to blame for many of these obstacles. 

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Rather than enacting redistributive policies - which inhibit one group’s economic opportunity in order to bolster another’s - we should consider financial reform that makes it easier for everyone to innovate, invest, and create jobs.  After the 2008 financial crisis resulted in the Great Recession, legislators’ misdiagnoses resulted in the knee-jerk response that is Dodd-Frank.  Dodd-Frank has now made it more difficult than ever for our high-growth start-ups to create new jobs. 

Dodd-Frank’s attempt to regulate financial instruments, such as credit default swaps and other credit derivatives, ignores financial entrepreneurs’ historical ability to find innovative ways to circumvent legislation.  For example, most major investment banks are already setting up ways to get around the limitations of the Volcker Rule, which is expected to take effect sometime this year.  It’s impossible for regulators to keep up . . . and they shouldn’t. 

All similar financial regulations follow the same pattern:  regulation is enacted, large, established, and resource-rich organizations find ways to elude oversight, and smaller start-ups and other businesses looking to grow are increasingly powerless to do so.    

Our current monetary policy only adds to prospective investors’ frustrations.  Discretionary fiscal policy leaves our nation’s financial future in the hands, and judgment, of whoever might currently be in power.  Uncertainty in regards to the future availability of capital, whether at the kitchen table or in the boardroom, impedes the incentive to invest.  Long-term economic growth will stop altogether without the investments of those willing to put it all on the line to start a business.  

But, in this environment of uncertainty, board rooms will always be more adept at finding ways to grow, leaving the little kitchen-table dreamers behind.  In fact, as of late, the amount of new investments by start-ups, along with the jobs created by these new enterprises, has dwindled.  Monetary policy should follow a stricter set of rules that removes the subjective decision-making power of well-intentioned, but unskilled fiscal administrators, in order to increase confidence and get entrepreneurs back in the game.

There are perhaps few types of regulations that have greater impact on income inequality and opportunity than tax policy.  Our tax code is so massive that federal tax law now comprises more than 74,000 pages.  In and of itself, the number of pages doesn’t matter as much as the complexity.  No CPA, or even an entire accounting firm, can know all of the intricate nooks and crannies of our tax system, not to mention the thousands of pages of new regulations that are added every year.  Because of this, those without means find it impossible to sustain 100 percent compliance.  Even the most parsimonious of small start-ups has to hire a public accountant to manage the books, which makes it harder for middle- and low-income families to start new ventures and improve their personal finances. 

On the other hand, a large company, or wealthy individual, can make the tax code work for them like no one else can.  For example, large, publicly-traded companies are increasingly creating Master Limited Partnerships (MLPs), which essentially act as pass-through entities similar to S-Corporations in order to obtain the same tax advantages.  Who ever heard of an MLP?  Individuals with financial resources can hire professionals to teach them how to “invest” in the government’s pet projects (e.g. one can invest in a “conservation easement” to ensure that a plot of land is never developed) providing a tax write-off twice as large as their investment.  Ever thought of purchasing a “conservation easement” tax credit?  I bet your congressman has.

If you want to see real inequality, one needs to look no further than Washington, D.C.  I’m not referring to the legislators at residence in the U.S. Capitol, or even the President himself.  The Washington metropolitan area has become the richest city in the entire country.  Why are the suburbs of our nation’s capital, populated by government bureaucrats and federal contractors, filled with more million-dollar homes than anywhere else? 

Whereas the president, and other legislators, like to talk about the problems of growing “income inequality” caused by the lack of “upward mobility,” they fail to realize that so many of the financial, tax, and other regulatory policies they’ve enacted are actually perpetuating it.  Washington policies, which have worked to increase the wealth of those businesses and affluent individuals who legislators so often deride in public speeches, have left the rest of the country to bear the economic burden of stagnation that they’ve created. 

Vélez-Hagan is executive director of The National Puerto Rican Chamber of Commerce, economic policy researcher at the University of Maryland-Baltimore County, and author of the upcoming book, Nousonomics: The Common Sense behind Basic Economics.