Building Utopia

Reasons for the Rich Getting Richer

Why do we have increasing wealth inequality? That is, why do the rich keep getting richer, and the poor keep getting poorer? The for-profit style of economy has several mechanisms that cause money to flow from the poor to the rich. These are just the mechanisms; they are intrinsic to for-profit economy; the mechanism is not the reason. Moreover, the for-profit economy is also not the reason. The for-profit economy works within the confines of several monetary systems that have been developed over centuries. These monetary systems have several kinds of unfairness; all of which contribute in the increasing wealth inequality. This chapter discusses these mechanisms and reasons.

This discussion is spread over several sections. The second-last section summarizes all previous sections for easy reference and contemplation. The final section wraps up this discussion and presents the obvious conclusions that can be drawn.

Economic Activity and Capitalism

All economic activity consists of transforming some resource into a more useful resource. This more useful resource is called a product or a service. To the extent the products and services are useful, economic activity creates convenience and well-being. Here is a simple perspective on various parts of any economic activity:

The Inputs: Some money is spent in obtaining the raw materials. Some money is spent on labor. Tools and machinery are required; these are the fixed assets needed to conduct the economic activity. It is possible to spend the money on these inputs because of the presence of Capital.

The Outputs: The fruit of the economic activity is some product or some service.

The Gain: This product or service is sold at some price. This selling price is typically higher than the total cost of creating the product or delivering the service. The difference between the selling price and the total cost is the profit.

The Owners: Those people who provided the capital to create those products or services, get to decide what to do with the generated profit.

Economic activity has the potential for generating profit. The potential for generating profit provides people with the motivation to create something that they perceive as valuable to others. Anyone who has the Capital can embark on this kind of economic activity. While individuals can create products and services, typically, creating products and services is done by businesses that are owned collectively by some people.

If one never uses the generated profit for spending on one's own needs and wants, then it can be added to the capital, and then the capital grows. This is wealth accumulation. With additional capital, one can produce more products and services, and generate more profit. The capital keeps growing over each "produce and sell cycle". This is the compounding effect, and it results in capital appreciation.

Instead of accumulating the profit and adding it to the capital, a business can choose to give the profit to its owners. This money that is given to the owners of the business is called a dividend. From the owner's perspective, it is dividend income.

The owner's gain in providing their money to a business as capital is that either they get a dividend income or their capital grows. All this does not require the owners to do any work.

Economic activity is a zero-sum money game. In order for someone to accumulate wealth, someone else has to spend it. We will discuss this aspect in detail in the next section.

Sometimes, people refer to this kind of wealth accumulation as wealth creation. In reality, wealth is not being generated, it is merely being accumulated. There is no such thing as wealth creation.

This is the gist of Capitalism.

Economic activity is desirable because of the convenience and well-being that it gives to the members of the society. Hence, a drop in economic activity can raise concern, because some convenience and some well-being is lost when economic activity reduces.

Economic activity is a positive-sum game of convenience and well-being. Hence, it is good for society.

Dollar Spent is Dollar Accumulated

In this book, whenever there is a need to discuss in terms of units of local currency of a society, we will use the term dollar to mean a unit of local currency.

A dollar spent by someone is a dollar accumulated by many others combined.

When we spend 100 dollars, we are buying some product or service from someone. When spending those 100 dollars, we are reducing our accumulated wealth by 100 dollars. So for us, any dollar spent is a dollar reduction in our wealth. What we are planning to show is that in an economy, every dollar spent is cumulatively accumulated by others.

To simplify the presentation of this logic, we will make the following assumptions:

  • Of every 100 dollars received by the seller, 50 go to various kinds of non-labor costs, 25 go to labor and 25 is the profit.
  • When labor is paid, the laborer treats the entire payment as profit.
  • Of all profit earned, the gainers of profit themselves spend half of it and accumulate the other half.

In the initial stage, someone gives us 100 dollars to spend. We call this initial stage as stage 0. In this stage, we spend 100 dollars. Thus, we spent all the initial 100 dollars, and we accumulated nothing.

The next stage of this consideration is stage 1. In this stage, we will consider what happens to those 100 initial dollars that we spent. Some organization got the 100 dollars that we spent. Of those 100 dollars, they retained 25 as their profit and spent 50 dollars on costs and 25 dollars on labor. Since the labor treats all its earnings as profit, in this stage, a total of 50 dollars were profit. Half of this profit, that is 25 dollars, were also spent. Thus, in all, in this stage, 75 dollars were spent, and 25 dollars were accumulated.

We will consider several such stages and apply the same assumed proportions for each one of these stages. In each stage, 25% of the earnings will be accumulated, and 75% will be spent.

In stage 2, someone received 75 dollars of the original dollars. Of these, 25%, that is 18.75 dollars, get accumulated. Similarly, of these 75 dollars of the original dollars, the remaining 75%, that is 56.25 dollars, are spent. In total, at the end of stage 2, accounting for all prior stages, 43.75 out of the original 100 dollars are accumulated by some people.

If we carry on this calculation, then in the 8th stage, only about 10 dollars of the original 100 dollars will be spent. Similarly, at the end of the 8th stage, 90 out of the original 100 dollars would have been accumulated by some people.

If we carry on this calculation, then in the 16th stage, only about 1 dollar of the original 100 dollars will be spent. Similarly, at the end of the 16th stage, 99 out of the original 100 dollars would have been accumulated by some people.

If we carry on this calculation, then in the 24th stage, only about 0.1 of the original 100 dollars will be spent. Similarly, at the end of the 24th stage, 99.9 out of the original 100 dollars would have been accumulated by some people.

If we carry on this calculation, then in the 32nd stage, only about 0.01 of the original 100 dollars will be spent. Similarly, at the end of the 32nd stage, 99.99 out of the original 100 dollars would have been accumulated by some people.

The process of earning and spending goes on indefinitely, and the mathematical concept of limit gets involved to let us conclude that of every dollar spent, a dollar accumulated by others.

If we change our assumptions, and for each stage we change the percentage of accumulated vs spent, then the number of stages to reach 99.99 % accumulated will differ, but the net result will be that eventually the entire amount spent is accumulated.

If we wish to account for taxes in the above discussion, then the taxes can be considered as one of the costs paid from each dollar received, and the profits will be the profits after taxes. It will reduce the profitability, but the logic stays the same, and its conclusion also stays the same.

If we wish to account for the depreciation of fixed assets in the above discussion, then the depreciation can be considered as one of the costs paid from each dollar received, and the profits will be the profits after accounting for depreciation as well. It will reduce the profitability, but the logic stays the same, and its conclusion also stays the same.

A Dollar Earned is a Dollar Accumulated

Whenever a person earns a dollar, that dollar immediately increases the wealth of that person. It is automatically saved and accumulated by that person. A dollar earned by someone is a dollar accumulated by that person alone.

In this context, by earning, for employees, we mean the wages earned in exchange for offering one's own time, knowledge and skills. Similarly, by earning, for businesses, we mean the profit earned by these businesses in offering their products and services. Since businesses are eventually owned by people, someone is earning those profits.

The source of our earnings, wages vs profit, is immaterial when considering how many dollars we have accumulated.

We satisfy all our needs and wants directly from the dollars that we have already accumulated.

Whether the accumulated dollar stays accumulated depends on one's spending needs. For how long an accumulated dollar stays accumulated depends on one's total accumulated dollars and one's total spending needs in a year.

When an accumulated dollar is spent, it causes the person's accumulated wealth to reduce. Spending by one, is earning for others; and hence an increase in the accumulated wealth of others.

When we spend X dollars using a credit card, we are promising someone else our future accumulated X dollars plus some more dollars in interest or late fees. Buying on credit card, most likely, will reduce the total dollars a person can accumulate.

Dollars Trickle Down When Invested

When some dollars get invested, they are either used for fixed assets or they are used as working capital; that is, buying raw materials, paying labor, etc. These freshly invested dollars provide additional money for some economic activity.

Since the additional money is used for economic activity, it gets spent on fixed assets, raw materials and labor. Every dollar spent in this way accumulates with someone else. Note that the products and services created by this economic activity usually recovers the money spent as investment by selling those products and services at some profit. We are not focusing on this money being earned by this particular business. Our interest is in considering what happens to the original money that was invested.

Some part of every dollar spent from this investment goes towards fixed assets and raw materials. They are typically purchased from some other businesses. Those other businesses have their own profit component of every dollar they earn. Thus, some part of every dollar spent, accumulates with some business owners.

Some part of each dollar spent from this investment goes towards labor. Thus, some part of every dollar spent accumulates with labor.

So, of every original dollar that was invested and spent, a part goes to the owners of some businesses and a part goes to laborers. With our simple assumptions from the previous section, 25% for labor and 25% for profit and remaining for other costs, if we add this over the stages of this dollar being spent, 50% goes to labor and 50% goes to businesses as profit.

How many people own businesses and how many people are laborers? Fewer owners and far more laborers.

Is the split between profit and wages in the same proportion as the proportion of owners vs laborers? No. It is more or less evenly split.

The implications of the prior two paragraphs are in the next two paragraphs:

From every dollar of additional investment, when individuals accumulate a part of it as profit, then on a per individual basis, this accumulated profit is significantly larger than half of the dollar.

From every dollar of additional investment, when individuals accumulate a part of it as wages, then on a per individual basis, this accumulated profit is significantly smaller than half of the dollar.

Since the portion of every dollar spent on starting a business and hence going to wage-earning laborers is small, we say that "dollars trickle down".

In this sense, when new money is invested, it "trickles down" to those who work to earn their living.

Dollars Trickle Up When Spent

A poor person has very little or no wealth at all. So any money that such a person spends has to come from the person earning it or someone else gave that money to the poor person. When a person is poor, it is also highly likely that the person does not earn an income at a high rate. So this person always has very little accumulated wealth to spend. Regardless of how a poor person gets a few dollars, the few dollars will not stay with the poor person for long; they will be spent. They will be spent because the basic needs of the poor person most likely have not yet been met. Even if the basic needs are being met, the additional money serves to satisfy some of their wants. This is totally natural. Thus, money accumulated by a poor person stays accumulated for a very short amount of time; the accumulated money is spent on survival, other basic needs and some wants.

The rich either have plenty of wealth from long ago and from which they earn their income, or they have a very high income in the recent past that they have been accumulating and hence they are now rich. Regardless of how a person gets rich, the person's needs and wants are satisfied and yet money is left over from the annual income. This money gets invested, usually generates profit, and aids in further accumulation of wealth without them having to do any work.

We have already seen that a dollar spent by one is accumulated by others.

If a poor person happens to accumulate a part of this dollar, usually by means of wages, then that part will most likely be spent soon. It will not stay accumulated for long.

If a rich person happens to accumulate a part of this dollar, usually by means of profit of some business owned by the rich, then that part will most likely stay accumulated for long.

If a middle-class person happens to accumulate a part of this dollar, either by wages or as profit from some investment, then that part will most likely stay accumulated for a moderate amount of time. The time depends on whether the middle-class person is closer to being poor or closer to being rich.

Thus, the only people who can effectively accumulate dollars are those who do not need it for any immediate spending needs. These people happen to be the non-poor. In this sense, dollars trickle up to the non-poor when spent.

Further, we already have wealth inequality. Of these non-poor people, the rich are in the minority and yet own a significantly higher proportion of the means of production. Thus, out of every dollar spent, the rich accumulate a significant portion of it. In this sense, dollars trickle up to the rich when spent.

Finally, let us clarify the meaning of "trickle" in this context. For a spent dollar to eventually reach a rich person, it needs to go through multiple stages of "dollar spent is dollar accumulated". A single dollar spent does not immediately reach some rich person. It trickles up through the multiple stages. But, it almost entirely trickles up to the rich.

Thus, dollars trickle up when spent.

Core Difference between Rich and Poor

The obvious difference between rich and poor is the total dollars that they have accumulated. A rich person has significantly more accumulated dollars than the poor person, and the poor person has close to nothing. Rich and Poor are in terms of accumulated wealth; not in terms of earnings.

The poor usually earn either nothing from their accumulated wealth or earn very little from their invested wealth. Thus, wages form most or all of the earnings of the poor.

The poor spend most of what they can earn and accumulate. That is, when compared to their earnings, the poor spend a large fraction of what they earn. Hence, they can effectively accumulate only a small fraction of their earnings.

In this context, by "spending", we do not mean buying durable assets which retain their value and can be easily resold for a price comparable to their purchase price. The poor are rarely in a position to do that. They are just spending to survive, and the money once spent is really gone. They get something in return for the money spent, and that something gets consumed immediately or soon after.

From the perspective of accumulated wealth, and considering a whole year's worth of spending on just the essential needs, ...

  • The totally poor person spends much more than their accumulated wealth.
  • A not so poor person spends comparable to their accumulated wealth.
  • A person with average wealth spends a fraction of their accumulated wealth.
  • A rich person spends a small fraction of their accumulated wealth.
  • A very rich person spends an insignificant fraction of their accumulated wealth.

Why? Because the essentials required to sustain life are the same for humans, the rich may buy luxurious products and the poor may buy cheap products, but because they are necessities, the price difference in the luxury and cheap products is insignificant when compared to the wealth and earnings of the rich.

The poor spend all their accumulated dollars on essentials and may still have some needs unsatisfied. They may be able to satisfy some of their wants, but they will have plenty of unsatisfied wants as well.

Moreover, the rich can effectively accumulate a much larger fraction of their earnings. Why?

Firstly, because the rich earn a percentage of their wealth as their earnings and the poor earn a fixed amount by means of their wages.

Secondly, as discussed above, the essentials don't cost a lot more for the rich than they do for the poor.

Thirdly, the rich even when they seem to be spending a lot for their wants, it is usually an insignificant portion of their wealth. Most of their wealth is "invested" and either growing or earning. The poor don't have much wealth invested for it to earn. Usually, poor people earn an insignificant amount of money through their invested wealth when compared to their wage earnings. All that results in the poor spending a significant portion of their accumulated wealth on their wants.

Finally, the rich also earn wages and these wages are at a much higher rate as compared to the poor people.

Since the rich can effectively accumulate a much larger fraction of their earnings, this additional accumulated wealth makes them richer. Moreover, this additional accumulated wealth can be further invested and it can also earn profits. Thus, the rich get richer at a compounded rate.

The poor can effectively accumulate a much lower percentage of every dollar they earn; or may be not at all.

Effectively accumulating a larger portion of the earnings is the main mechanism for the rich getting richer.

The poor never get an opportunity to accumulate sufficient wealth so that the earnings from the wealth could support the life of the poor. The rich most definitely can support their life purely based on the earning from their wealth.

The poor must work just to survive, and the rich need not work for their survival. In fact, the rich can lead a very good life only on the earnings from their wealth.

Investment by individuals is the key characteristics of a capitalistic society. The rich invest and own businesses that generate profit, and the rich don't need all that profit for their spending needs. Thus, they can effectively accumulate wealth. On the other hand, the poor always face money scarcity for even their essential needs. Thus, whatever money the poor get or earn is spent.

Thus, in a purely Capitalistic society, the rich will get richer, wealth inequality will increase. If a society was a purely Capitalistic society, then this will need to be addressed in some way.

But a society never practices pure Capitalism; there is the concept of common good, there are taxes, there is social welfare, and there are many other considerations. Besides, the possibility to earn a profit is a good motivation for people to do useful work and provide value to others. So, getting rid of Capitalism is a bad choice. The next chapter discusses this aspect further.

Monetary Benefit of a Society

The main mechanism by which the rich get richer is wealth accumulation. It is just a mechanism; it is not the reason. It is just the nature of capital-based economic activity. It isn't due to any inherent unfairness. This point requires elaboration.

It is fair to be able to have wealth. It is fair to be able to decide what to do with the wealth that one has. The choices for this decision are: spending it, saving it, investing it, or giving it away. It is fair to invest the wealth for any non-prohibited purpose and earn some profit by doing it. It is also fair that when one gets far more profit than one needs to use for one's needs and wants, then one should be able to accumulate it. Similarly, it is fair for many people to compete in the same industry where all of them try to earn their wages or their profit by doing the same kind of thing.

Without a society, survival will require a lot of uncomfortable and hard work, but it is possible. A society of just two people makes barter possible. But, wealth accumulation simply cannot be done without a conducive society to do it in.

Society spends a lot of money in protecting its borders, maintaining internal law and order, creating different kinds of common infrastructure, educating people and making them more useful, establishing standard and regulating activities, etc. Society establishes an ecosystem in which economic activity can occur.

In the context of this social ecosystem, the monetary benefit accrues only to those who either have already accumulated some money or have something so special to offer that many others give them their money. Having accumulated money presents an opportunity to invest and accumulate more money.

The rich have the opportunity to invest the accumulated money in some profitable and well-managed business that creates some product or some service that is in demand. The rich are perfectly positioned to take up such opportunities. Usually they take them up, invest their accumulated money and start accumulating more money.

Middle-class people also have the opportunity to invest in some profitable and well-managed businesses. Their opportunity is commensurate with their accumulated wealth; but existing wealth inequality means that they possess only a small fraction of the accumulated wealth. If and when their earnings cease, due to unemployment or retirement or some misfortune, they still have needs and wants, and that forces them to spend the accumulated money that they may have saved or invested.

The poor never have this opportunity because they hardly have any accumulated money. Even if they have some accumulated money, they need to use it to satisfy their essential needs and perhaps some wants. Their only option is to accumulate more money than their needs and wants. They can do so only if they have some skill or some talent or some knowledge that is hard to find and also in great demand so that they can get great wages. Most people, including the poor, have no such knowledge, talent or skills to offer, and they face competition from similar other people, and that drives down the price of the wages that they can earn. Thus, accumulating money is not really possible for the poor.

So, all the non-rich people either are merely surviving or are having a normal life; all the while letting the money that they spend trickle up.

Wealth accumulation is the mechanism that results in the rich getting richer, and this mechanism is available only to those who have some accumulated wealth. But, without a society, wealth accumulation is impossible.

The monetary benefit of a society is to be able to accumulate wealth.

This monetary benefit accrues most to those who are already rich. Others only have a hope that they can get rich. Only a very few of the others can get rich, and that too only because they have some talent that can be used in a conducive society. Without such a conducive society, that talent would not fetch them riches.

In a society that has no taxes, these factors will result in the rich getting richer. In such societies, there will be very few rich people who will end up accumulating all the wealth in the society and owning everything.

Monetary Cost of a Society

Taxes are needed to support the common good that a society aims to deliver. Thus, taxes are inevitable. Tax is the monetary cost of a society.

It is important to discuss the basis on which taxes are levied in societies; since that is open for thought, discussion and change.

This section has the following goals:

  • Mention that there are three fundamental basis for taxation. They are earnings, consumption and wealth.
  • Demonstrate that all present-day taxes indeed are on one of these fundamental basis.
  • Discuss that most of the taxes collected by present-day societies are on the basis of earnings and consumption.
  • Discuss that some taxes based on non-wage earnings are effectively taxes based on wage earnings and consumption.
  • Finally, pose the question: "Are the current basis for taxation fair?" accompanied with hints for the answer.

In most societies, taxes are collected at national, regional and local level. We will discuss taxes at all these levels combined.

There are only two core ways in which taxes can be levied. One is on the basis of some transaction and the other is on the basis of possessing something. The first way can be further split into three kinds of transactions: earnings, consumption, and trade.

Thus fundamentally, there can be only 4 possible ways:

  • earnings
  • consumption
  • trade
  • possessions: that is, wealth.

We need to clarify what we mean by "trade" in this context. It does not mean foreign trade. In this context, "trade" means is any kind of trade within a society that cannot be classified as wages or sales to consumers. For a better understanding, here are some examples of trade kind of transactions:

  • an individual buying ownership shares in some organization
  • an individual selling ownership shares in some organization that one owns
  • a wholesaler buying a large batch of products from a manufacturer to sell that batch to several retailers
  • a retailer buying some goods from a wholesaler to eventually sell to customers
  • a manufacturer buying some raw materials from suppliers to convert them to finished products.

From these, it makes no sense to levy tax on trade kind of transactions. S

The main reason why it makes no sense to levy tax on such trades is as follows: Note that such kinds of trades are a transfer of assets from one owner to another in exchange for money. If such a transfer attracted taxes, then it would significantly hamper and dissuade economic activity in a society. Businesses would favor "vertical integration", they would be reluctant to buy raw materials from other business in the hope of saving the transaction tax and hence lowering costs.

Thus, a trade kind of transaction tax is not feasible if a society desires smooth conduct of economic activity. Even the present-day societies avoid such kinds of taxes. So, we will remove this kind of tax from this discussion.

Thus fundamentally, there can be only 3 basis for taxation:

  • based on consumption
  • based on earnings
  • based on the wealth possessed

Now let us demonstrate that all major kinds of taxes in present-day societies belong to one of these basis.

Following are the major kinds of taxes that account for most of the tax revenue in most societies:

  • Consumption Tax or Sales Tax or Value-Added Tax
  • Sin Tax
  • Manufacturing Tax
  • Customs Duties
  • Excise Tax
  • Wage-based Tax or Personal Income Tax or Payroll Tax
  • Dividend Tax
  • Short-term capital gains tax
  • Long-term capital gains tax
  • Corporate Income Tax.
  • Inheritance Tax
  • Property Tax

Consumption tax is paid when a consumer buys something from a retailer. The sin tax, manufacturing tax, customs duties and the excise tax are on some goods. The presence of these taxes increases the price paid for buying those goods, and those goods are eventually sold to customers who pay that higher price in order to consume those goods. In effect, all these taxes can be considered as taxes based on consumption, and they are ultimately paid by the consumers.

The taxes on wages, dividend tax, short-term and long-term capital gains taxes are all on earnings; regardless of whether they are wage-earnings or earning from profit. Corporate income taxes are taxes on profits of corporations and hence they too are based on earnings.

Inheritance tax, while occurring rarely in the lifetime of an individual, can be easily considered to be a tax on such rarely occurring "earnings".

The Property Tax, is usually charged at the local level. It is charged as a small percentage of the property value (value of real estate) owned within that locality. Real estate is part of the total wealth of the citizens, and hence this kind of tax is in the category of wealth-based tax.

The chapter "Wealth Based Taxes" provides a table for government expenditure as a percentage of wealth. That number is in the 6% to 10% range.

If one looks at the property tax rate at various localities, it is approximately in the 1% range.

If one estimates that the entirety of wealth of a society is in real estate, then property taxes are less than one-fifth of the total taxes collected. If one estimates that about half of the wealth of a society is in real estate, and this is a better estimate, then property taxes are less than one-tenth of the total taxes collected.

Thus, wealth-based taxes, in present-day societies constitutes less than 10% of the taxes collected. The remaining taxes, that is more than 90% of taxes, are either on the basis of earnings or on the basis of consumption.

That is, most of the taxes collected by present-day societies are on the basis of earnings and consumption.

It may seem that corporate taxes are paid by corporations, in effect, wage earners and consumers pay it. How? Here is an explanation...

If corporate taxes did not exist, and if owners of the corporation were satisfied with the same absolute amount of profit-after-tax, then that corporate tax money which was never paid, would have resulted in a combination of higher wages for the corporate employees and lower prices for the customers of the corporation, and that would have eventually resulted in lower prices for items that consumers would buy from retailers. Thus, in effect, individuals are paying for the corporate income tax through a combination of lower wages or higher prices (for the goods and services that they purchase and consume).

A different perspective on the same situation is as follows: if the society had to eliminate only the corporate taxes without increasing the post-tax profitability of the corporations, and yet had to raise the same amount of tax revenue, then after eliminating the corporate income tax, corporations would have to raise wages and lower prices, and then the society would have to raise the tax rate on wages and consumption (i.e. sale of consumables), in effect negating the risen wages and lowered prices.

Similarly, any taxes that are explicitly levied on dividends can be thought of on lines similar to the discussion about corporate income taxes, and one draws a similar conclusion about them that taxes on dividends are, in effect, paid by wage earners and consumers.

Thus, some taxes based on non-wage earnings are effectively taxes based on wage earnings and consumption.

We have seen that earning and consumption form the basis for more than 90% of taxes currently collected. We have also seen that taxes on some kinds of the non-wage earnings are, in effect, taxes on wage-earnings and consumption.

Thus, wage-earnings and consumption is the current basis for collecting a significant proportion of taxes.

Without a society, survival will require a lot of uncomfortable and hard work, but it is possible. A society of just two people makes barter possible. In primitive societies, wealth accumulation was not possible; because the primitive society was not capable enough to either provide infrastructure through which wealth accumulation was possible, and also provide legal and physical protection for the accumulated wealth.

The ideas of work and barter from primitive societies are equivalent to the ideas of earn wages through employment and consume by purchasing something in modern societies. Wealth accumulation is possible only in a conducive and modern society.

The monetary benefit of a society is the accumulated wealth. The monetary cost of a society is tax. Currently, a significant proportion of taxes are based on wage-earnings or consumption. So, are the current basis for taxation fair? We will answer this question in the "Conclusion" section.

Monetary Sovereignty

A society is a Monetary Sovereign if it has the following powers:

  • The power to create a standard of value; that is, the local currency.
  • The power to collect taxes.
  • The power to create some more local money and currency.
  • The power to destroy some local money and currency.

We already know that most countries can set their own standard of value; that is, their own currency. Similarly, countries collect taxes.

We already know that most countries mint their coins and print their notes. This is creating local money and currency. Similarly, when they destroy worn out coins and notes, they are destroying local money and local currency.

The Euro Area is a monetary sovereign because it has all the above powers. Note that the taxation powers in the Euro area are delegated to their constituent countries.

Economic events in the recent decades have shown us that most countries can also create some more local money digitally. Usually, the term "Quantitative Easing" or "printing money" is used for this form of money creation. This is possible only when the local money is Fiat Money. This is not possible when the local money is complying with the Gold Standard.

Monetary Sovereignty is a simple idea and incredibly useful in more than one way.

Trickle-Down and Trickle-Up Economics

Most societies adopt "Trickle-Down Economics" to some extent. In this kind of economics, the society gives some money to someone, either directly or indirectly, for investment purposes. The intent behind it is that some part of this investment money trickles down to the poor in the form of creation of new jobs and wages to do the new jobs.

Note that the meaning of the term investment for a society is not limited to the initial investment. When society invests and creates some infrastructure, then all subsequent spending to maintain the infrastructure should also be considered as ongoing investments.

The money for investment in Trickle-Down Economics can come from the following sources:

  • Taxes collected from all citizens.
  • Society borrowing from its citizens.
  • Society using its monetary sovereignty to create new money.

Societies adopt "Trickle-Up Economics" to a lesser extent. In this kind of economics, society gives some money to the poor to spend on their needs.

When this kind of economics is in play, the money for spending in Trickle-Up Economics can come from all the same sources as those for Trickle-Down Economics.

Let us compare these two kinds of economics. In Trickle-Down Economics, the money is intended for investment. In Trickle-Up Economics, the money is intended for spending on the needs of the poor. Let us assume that society decides to use a trillion dollars.

With the 1 trillion dollars used for Trickle-Down Economics, society chooses who gets the trillion dollars as investment capital. As a side effect of the additional investment, it manages to give some jobless people jobs and helps them survive. We have seen in the section on "Dollars Trickle Down When Invested" that only a fraction of the entire money allocated to investments actually trickles down to the poor. This is why "Trickle-Down Economics" never achieves anything useful beyond the mere survival of some additional poor.

With the 1 trillion dollars used for Trickle-Up Economics, the entire 1 Trillion is made available to all the poor to help them in their spending. The poor select the kinds of things that they spend it on, and hence they decide which businesses eventually get the money as it trickles up. Thus, in Trickle-Up Economics, the deserving businesses tend to eventually get the money.

The challenge in implementing Trickle-Up Economics is to decide who is poor and should get the money to spend, and who is not poor and hence should not get the money to spend. Some wealth threshold can be established to make this decision, but those citizens who miss out the opportunity of getting this money, because they were just above the threshold, feel that they have been unfairly excluded.

It is worth noting that the trillion dollars, in either case, eventually ends up in the hands of the rich.

Between the two, Trickle-Up Economics is better than Trickle-Down Economics. This is so because the poor at least get to spend all those trillion dollars, rather than just a fraction of it. Another reason is that the decision about which businesses should eventually get the money is in the hands of the poor, and is directly related to their needs and wants.

Let us consider "Trickle-Down Economics" and/or "Trickle-Up Economics" financed by taxes. In this kind of economy, the citizens bear the entire cost of investment or spending. This kind of economy does not impact the ability of the rich to generate profit and accumulate more wealth. This kind of economy adversely impacts the ability of everyone else to support their own needs from their own earnings. These taxes directly impact the poor; they lose some of the money that they have earned; this money lost to taxes is the money they cannot spend to satisfy their needs, and they get reduced quality of life. This increases the speed of increasing wealth inequality.

Let us consider "Trickle-Down Economics" and/or "Trickle-Up Economics" financed by debt. This kind of economy maintains the ability of the rich to earn profit in the present time frame. This kind of economy recovers the cost to pay the interest on the debt from everyone in the present time frame and in the future as well, and it recovers the cost to pay back the debt from everyone in the future. Everyone includes the poor and even citizens that are not yet born. This sustains the increasing wealth inequality over a longer time frame.

Let us consider "Trickle-Down Economics" and/or "Trickle-Up Economics" financed by freshly created money. In this case, the citizens do not bear any direct cost for the investment or spending. However, all citizens bear all the consequences of the increased money supply. This kind of economy increases the quantity of money in the economy without adding any ability for the poor to accumulate wealth. All that additional money goes to the rich. This too increases the speed of increasing wealth inequality.

Other Tax Unfairness

Some societies give tax exemptions and tax holidays for businesses. This shifts the responsibility of taxes from these businesses to everyone else. That includes the poor. This adds to the speed of increasing wealth inequality.

Some societies allow a lower tax rate on income from investments than the tax rate on wage income. This favors the rich; because only those who have more money than they need can invest and earn an income from such investments. This adds to the speed of increasing wealth inequality.

Some societies allow a lower tax rate on long-term capital gains than the tax rate on wage income. This favors the rich; because only those who have more money than they need can invest for a long-term. This adds to the speed of increasing wealth inequality.

Current societies tend to think that "high wage income" equates to "richness". So, when high wage income earners are taxed at a higher rate than the low wage income earners, it is thought of as though the rich are getting taxed at a higher rate. There are two problems with this line of thinking.

First, imagine a few poor people who have some natural advantage, these people start using that advantage in their employment, and start becoming more useful to their employers, as a result they start earning higher wage income from their employers, with higher wage income they are faced with the situation that they need to pay taxes at a higher rate. Why does higher wage income attract a higher rate? When tax is based on wage income and it is proportional to the wage income, then asking some to pay a higher proportion and some to pay a lower proportion is discriminatory. In order to be fair, and if wage income is the basis for taxation, then the rate at which everyone pays taxes on wage income should be the same.

Second, if the intent is to make the rich pay their fair share of taxes, and if taxing higher wage income at higher rate is the intended mechanism to achieve this fairness, then the mechanism is totally flawed. Why? Because the mechanism does not tax the rich on their wealth at all. The rich get the full help and benefit of the society in protecting and growing their wealth. The growth in the wealth appears as "dividend income", not as wage income, and only that dividend income gets taxed at a different rate than the wage income. The rich have to merely invest and can earn high income, while the poor have to do something extraordinary to earn a high income through wages. The social benefit to the rich accrues to their entire wealth, not just to the income from that wealth; while the poor, because they do not have the wealth, do not get this social benefit at all.

In reality, high wage income is a path to richness; not richness itself. Higher tax rate on higher wage income is more like a penalty on being more useful, more productive, and more valuable. It is a penalty because the higher wage attracts a higher rate of tax.

Thus, higher tax rate on higher wage income is discriminatory and unfair. Moreover, such a taxation system does not make the rich pay their fair share of taxes.

When someone is excused from doing their duty of paying taxes, then all others are burdened with the amount excused. When the rich get excused, the poor bear the burden, and they get poorer; and that contributes to the increasing wealth inequality.

Fiscal Deficit Unfairness

Societies spend money to do things for the common good of the society. Usually they collect this spending money using taxes. However, the spending and taxes are almost always never balanced.

For the past several decades, governments of societies have been incurring deficits in most years. These deficits are financed using debt, and these debts are increasing. Every year, governments have been consistently collecting less taxes than planned expenses, and then fund those deficits using debt.

Such debts have to be eventually repaid along with the interest due on that debt. Who is supposed to pay these debts?

Debts are usually repaid through taxes. Thus, citizens have to repay these debts. When debts last several years or several decades, we are delaying the collection of taxes to pay for our expenses and spending. Essentially, we are forcing those citizens that are not yet born to pay for our current spending needs and wants. The longer we do not repay the debts, the more we hold our children, our grandchildren and our future generations responsible to take part in repaying our debts. Essentially, we are placing the burden of our current spending needs on our future generations. We are shirking our responsibility.

An ever-increasing fiscal debt is unfair to those who are not yet born or were too young at the time the debt was incurred, because eventually they will have to pay it down, but they did not get to choose to incur the debt. When our future generations are made to pay for our spending, they all get that much poorer.

Moreover, the existence of fiscal deficit reduces the spending capacity of our the future generations to spend on the things that they consider more worthwhile. By accumulating fiscal deficit, we are limiting the choices of our future generations.

The Problem of Monetary Inflation

When we hear the term "inflation", we think about the prices of various things that we buy. The price level of the commonly purchased things seems to be going up, and this is commonly termed as inflation. When the price goes up, the purchasing power of the same amount of money goes down.

Then there are terms like "stagnation", "stagflation", "recession", "depression" and they are projected as problems that need to be solved. Stagnation is a situation when the economic activity is neither growing nor shrinking. Stagflation is a combination of stagnation and inflation. Recession is when the economic activity shrinks and this situation lasts for a relatively short amount of time. Depression is when the economic activity shrinks for a relatively longer amount of time. All these are related to economic activity and hence related to money.

A simplistic way of conveying the gist of the meanings is as follows: It is stagnation when my salary does not go up. It is stagflation when my salary does not go up but the things that I need to buy become more expensive. It is a recession when one of my neighbors loses his job. It is depression when many of my neighbors lose their jobs. And, it is a total economic disaster when I lose my job. Bear in mind that this is a simple way to convey the distinctions in as few words as possible.

Those in charge of addressing these problems have been trying to counter the above-mentioned problems in many discretionary ways. There have been times when price controls were implemented. The central banks routinely influence short-term interest rates. More recently, they have resorted to influencing the longer term interest rates. Liquidity, credit-crunch, quantitative easing (QE), QE2, QE3 and QE-forever have become common terms and tools of dealing with these problems.

There is one predominant line of thought that underlies all these problem-solving approaches, and it is as follows: "1 or 2 percent inflation every year is desirable and hence should be accomplished." This line of thought believes that the presence of inflation is good.

Inflation in prices is the tip of the iceberg. The iceberg is the fact that we have chosen "increasing wealth" as the basis of our well-being and also as our goal. Quantitative easing, or printing money, or printing digital money, is the main cause of monetary inflation in recent times. If we chart the total monetary value of the wealth of the entire world, it seems to be increasing all the time. So, it seems that we always have more money in our society, and this seems to be a good thing. If it were a good thing, we would not have the situation of the poor getting poorer and more people getting pushed towards poverty.

The common inflation in prices of the things that we routinely buy is just a side effect of this monetary setup using increasing wealth as its basis.

The dwindling purchasing power is a consequence of the increasing wealth and the rich getting richer. Those two combined ensure that the rest (that is, the non-rich) are left with relatively less amount of money, and that less amount of money reduces the affordability of necessities of life. Of course, technological advances make some things cheaper or better; technological advances make new things possible. But in spite of all those technological advances, we still have poverty; we still have inflation in the prices of essentials. That is making more people less capable of buying the same things, and this means that more people are getting poorer. This causes a ripple effect in the general level of economic activity, and we see these ripple effects as stagnation, recession and depression.

Monetary inflation clouds our judgment of "value". Creating more money is a tool, and this tool has been used to introduce unsustainable "quick fixes" that introduce more problems. Discretionary monetary inflation increases uncertainty about future price level. All that makes planning for the longer term more difficult; that includes planning for retirement and old age.

The Problem of Imbalanced Foreign Trade

Societies trade with other societies primarily in the raw materials that cannot be obtained within the society. In addition to the raw materials, societies trade with each other for the convenience of obtaining products from those who can make them, or from those who can make them cheaper. In all this trade, there is rarely a balance. Some societies have an export surplus and some societies have an export deficit when compared with their imports.

When we import something, the importing society benefits from that consumption, because either it cannot be made within the society or it cannot be made cheap enough. When we export something, other societies benefit from that consumption, because either they cannot make it or they cannot make it cheap enough.

Exports provide local employment opportunities, and imports take away local employment opportunities. When a society has excess imports over exports, this "imbalance" induces some level of unemployment within the society. Unemployment leads to poverty. Those who get unemployed as a result of this imbalance pay the price for the convenience or lower cost that other people get.

From a monetary perspective, who benefits in all this? Those who import and make a profit selling those imports locally. These people are adding to their accumulated wealth at the expense of someone else in the society. Thus, an excess of imports over exports adds to the increasing wealth inequality. However, this blame cannot be pinned on specific importers. The blame lies with the society for allowing the imbalance.

Imbalanced trade results in a drain of natural resources from the country that has a deficit of exports over imports. When we have balanced foreign trade, the resources going out and resources coming in are balanced. There is no resource drain or gain. Balanced trade is mutually beneficial.

This imbalance is the main cause of many trade disputes and trade wars.

Overall, imbalanced foreign trade hurts citizens and balanced trade is desirable. Not having any effective side-effect-free mechanism to ensure a balance in foreign trade is a significant oversight in present-day societies.

Summary of Reasons

We have discussed many things, so it is useful to summarize it all here before presenting the conclusion:

  • The profit motive drives most of the Economic Activity, and it is desirable.
  • How Money Flows and Accumulates
    • A dollar spent is a dollar accumulated
    • A dollar earned is a dollar accumulated
    • Dollars trickle down when invested
    • Dollars trickle up when spent
  • Spending Difference between Rich and Poor or Mechanism of Rich Getting richer
    • Effectively accumulating a larger portion of the earnings is the main mechanism for the rich getting richer. Rich can do it, others cannot do it as effectively or at all.
  • Monetary Benefit of a Society
    • The monetary benefit of a society is the accumulated wealth.
    • The monetary benefit of a society is not the opportunity to accumulate wealth and become rich. While the opportunity exists, it is not equally available to all. Most people have such an opportunity only to a very small extent.
  • Monetary Cost of the Society
    • The monetary cost of a society is the tax that we must pay. These taxes support social spending needs to ensure the common good.
    • What is the current basis for collecting taxes? The significant proportion of taxes collected by present-day societies is in the form of taxes on wages and taxes on consumption by citizens.
    • While the monetary benefit of a society is accumulated wealth, it is an insignificant basis for taxation.
    • This is the largest unfairness in our current taxation system.
  • Trickle-Down and Trickle-Up Economics
    • Most of social spending can be classified as either Trickle-Down Economics or Trickle-Up Economics
    • When this kind of social spending is funded on the basis of wage-based taxes or consumption-based taxes, it increases the speed of the rich getting richer.
    • When this kind of social spending is funded on the basis of debt, it sustains wealth inequality over a longer time frame.
    • When this kind of social spending is funded on the basis of freshly created money, it causes monetary inflation, and it increases the speed of the rich getting richer.
  • Other Tax Unfairness
    • Our present-day societies also have other kinds of tax unfairness like: tax exemptions, tax holidays, lower tax rate on investment income, and lower tax rate on capital growth.
    • Higher tax rate on higher wage income is discriminatory and unfair. Moreover, such a taxation system does not make the rich pay their fair share of taxes.
    • All these kinds of tax unfairness contribute to increasing wealth inequality.
  • Fiscal Deficit Unfairness
    • Most societies currently have an ever-increasing fiscal debt.
    • An ever-increasing fiscal debt is unfair to those who are not yet born or were too young at the time the debt was incurred, because eventually they will have to pay it down, but they did not get to choose to incur the debt.
    • When our future generations are made to pay for our spending, they all get that much poorer.
  • The Problem of Monetary Inflation
    • Monetary inflation clouds our judgment of "value".
    • Creating more money is a tool, but it can be used to introduce unsustainable "quick fixes" that introduce more problems.
    • Discretionary monetary inflation increases uncertainty about future price level.
    • All that makes planning for the longer term more difficult; that includes planning for retirement and old age.
  • The Problem of Imbalanced Foreign Trade
    • When excess imports over exports cause local unemployment, it is unfair to those who suffer that unemployment and resulting poverty.
    • Presence of such an imbalance adds to the increasing wealth inequality.

The above summary contains examples of many kinds of monetary unfairness. All these combine to create the increasing wealth inequality; that is, the rich getting richer.

The only reason why our societies have not degenerated into a dystopia is due to the presence of social welfare systems. Even these are not well-designed. A poorly designed social welfare system will not help the citizens as much as a well-designed social welfare system. But, for sure, a poorly designed social welfare system is not the main contributor to either the wealth inequality problem or the increasing wealth inequality problem.

Conclusion

We have seen many mechanisms and many kinds of unfairness in our monetary systems that all contribute to the increasing wealth inequality.

Spending and paying taxes are the only two ways in which accumulated wealth reduces. So, if the rich are getting richer, clearly they are not spending enough, and clearly we not collecting enough taxes from them.

We obviously cannot demand that the rich spend their riches; because it is their freedom to spend it however they choose. However, we can demand that they pay taxes on some fair criteria and hopefully that fair criteria can stop the increasing wealth inequality, and also bring sanity to the wealth inequality.

We have discussed, in the section "Monetary Cost of a Society", that our societies use income (i.e. mostly wage-based earnings) and sales (i.e. consumption), directly or indirectly, as the significant bases for taxation. These bases are transactional in nature; the underlying idea is: "if you do something, you pay a tax".

The transactional nature of income and sales taxes make them punitive. When someone tries to earn some money to make their life better, they have to pay a tax. When someone tries to buy something to make their life better, they have to pay a tax. That is the simplest explanation for why these two kinds of taxes are punitive.

Income and sales taxes make things costlier for the non-rich who have to work; either they have to work more or they have to consume less. On the other hand, income and sales taxes do not hinder the net profitability of the rich; they still can charge sufficiently to ensure that their post-tax profit is a decent percentage of their invested wealth. Thus, even in the presence of income and sales taxes, the rich keep getting richer; and we get increasing wealth inequality.

We have also discussed that in "Trickle-Down and Trickle-Up Economics" funded by taxes, all that tax money eventually ends up with the rich.

So, income and sales taxes have fairness issues, and they cannot be the counterbalance to the situation that the rich keep getting richer.

If a society needs to levy taxes, then taxes need to be based on some fair criteria. Ideally, it should be the most fair criteria. This implies that the criteria chosen should be non-discriminatory. That means that picking one or more "basis" for taxation as these basis are the only plausibly non-discriminatory criteria.

Income tax and sales tax originated because "society needed to collect more taxes" and "they are easy to collect"; since a monetary transaction is already occurring, and society could make rules about such monetary transactions. Up until recently, because technology was not yet well-developed, the "ease factor" may also have been relevant, but no more.

Now, let us consider wealth as a basis for tax. What is a wealth-based tax? Wealth-based tax is a single rate of tax, and it is expressed in percentage of wealth. So, a wealth-based tax rate of 2% means that 2% of wealth needs to be paid as taxes by everyone every year.

Wealth-based tax raises taxes from an individual in the same proportion to the monetary benefit that the society has already given to that individual. The monetary benefit is the total wealth accumulated by the individual. In dollar terms, the poor person derives very little benefit and the rich person derives a lot of benefit. In terms of the tax rate, the rich and the poor pay at the same rate; there is no discrimination.

Wealth-based taxes are fair because they are "in proportion to the monetary benefit derived" and they are "non-discriminatory". So, wealth can be a fair basis for taxation.

An appropriate percentage of wealth-based taxes, will not prevent people from getting rich, will not prevent some deserving rich from getting richer, but it will prevent the uncontrolled rising wealth inequality. Wealth-based taxes will place a natural limit on wealth inequality. Wealth-based taxes in combination with a well-designed social welfare system will help everyone achieve a good life.

There are only three fundamental basis on which to levy taxes:

  • levy tax when someone earns some money (i.e. income tax)
  • levy tax when someone spends some money (i.e. sales tax)
  • levy tax when someone has some money (i.e. wealth-based tax)

With today's technology, we could levy tax using any combination of these bases. Of these, income tax and sales tax have fairness issues, and they do not serve as a counterbalance to increasing wealth inequality; in fact, they add to it. So, wealth-based tax is the only fair counterbalance to increasing wealth inequality.

If income and sales can be considered as basis for taxation, then why is wealth (not just real estate) not being considered as a basis for taxation? We tend to frequently discuss raising or lowering the rate of income tax or sales tax. Why is there no discussion about wealth-based tax?

Choosing transactional bases for taxation, and ignoring wealth as a basis for taxation, is the primary unfairness in present-day societies. This unfairness together with all other mechanisms and unfairnesses mentioned in this chapter results in the rich getting richer and increasing wealth inequality.