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Warren Buffett recently met with MBA students to discuss his outlook on the world.  Dr. David Kass was kind enough to post his notes to his website.  I thought Mr. Buffett’s comments regarding income inequality were particularly pertinent.  He said:

(21) Question about income inequality in the U.S.

WB: During recent years of economic growth in the U.S., income inequality has grown.  It’s going to exist in capitalism and it should.  If everyone is promised to come out equal in the end, then we would have a different world.  Suppose that 24 hours before you were born a genie appears and gives you an incredible responsibility to design an economic, political, and social system in which you are to emerge.  Whatever you decide is the society for you, your children, your grandchildren, etc.  You then ask the genie, “what’s the catch”?  The answer is that just before emerging you have to go to the barrel with 6.5 billion tickets, one for each person in the world, but you do not know which ticket you will get (ovarian lottery.)  A society with equality and no production would not be good.  You should think of output, providing incentives to people, an abundant society, a market system.  In the U.S. per capita GDP equals $47,000.  We want freedom from fear of not receiving health care and not starving to death.  An abundant society will take care of people that get a lousy ticket.  Inequality of the tickets is what you want to deal with.  We are working toward that in this society.  Social Security is an attempt at that in our society.  In the last 20 years we have been moving in the wrong direction.  According to the IRS, in 1992 the 400 highest incomes averaged $45 million.  In 2009, they averaged $350 million.  The rest of the U.S. went no place over these years.  The average tax rate for the highest income earners has declined from 28% down to 16% over this time period.  His average tax rate is 16% on $16 million of income, largely from dividends and capital gains which are taxed at 15%.  He has no tax shelters and does not consult tax advisers.  He credits George Bush and the U.S. Congress.  We have moved away from equality to taking care of the rich.  If you and a twin were competing for a ticket in the U.S. or Bangladesh (with no income tax), you might bid 70% – 80% (of future wealth) to get the U.S. ticket.  He is lucky that he is alive now rather than thousands of years ago.  Otherwise he would have been some animal’s lunch.  It would not have done him any good then to say “I allocate capital”. We should have a society that will incentivize people to work hard and the ticket you pick doesn’t destine you for a poor outcome.

I agree here.  Income inequality is not the problem by itself.  But I still don’t think Mr. Buffett goes far enough.  What has become an increasing problem in the United States is that we incentivize workers to engage in work that is not highly productive.  We pay them for not working.  We give them rebates for buying cars they don’t need or houses they can’t afford.  But the most glaring example is the financial sector which produces little and takes much.  Meanwhile we value our doctors, teachers and entrepreneurs far less.

The fix in my opinion begins with the theories and workings of government that we have all become so enamored with.  In particular, this means recognizing that the financial theories of the 70’s & 80’s that helped create this crisis, were in fact wrong.   De-regulation did not help.  Monetarism and its incessant focus on the Fed and money supply have helped build a banking behemoth that promotes cannibalistic capitalism.  Free market capitalism does not apply to the banking system.  And this means altering the Fed’s role in markets and the role that banking and finance plays in US economic growth.  If these problems are not fixed I fear the the unproductive income inequality gap will increase.  And as the middle class becomes increasingly disgruntled our capitalist system will become increasingly fragile due to the very free market principles that helped build this financial behemoth.   Capitalism works, however, we have taken its principles to an extreme.  If they are not reined in they will continue to eat at the US economy.

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