Discovery Institute’s Center on Wealth, Poverty, and Morality, provides original reporting and analysis at the intersection of ethics, faith, and economics.

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How Washington Widens Gap Between The Rich And Poor

Critics of growing inequality who blame the market for distributing wealth unfairly and rewarding the rich at the neglect of the poor have it partially correct.

Everyone knows that in competitive markets, as in sports and academics, outcomes are not equal. The problem of flagging upward mobility is rooted in subpar economic growth and lackluster creation of the specific kind of job that leads to more and better opportunity.

Those who think government should fix this problem need to first recognize that Washington's current trajectory of regulatory and monetary policies has crimped economic growth and widened the gap between rich and poor.

While hidden, the costs of federal government regulations are now estimated at about $1.9 trillion annually -- more than 11% of GDP and more than 50% of federal government spending. Which is to say that the real cost of the U.S. federal government is half again as much of the $3.6 trillion it actually spends, or almost a third of the nation's $17 trillion GDP.

The burden on the private economy is greater than official numbers suggest, and the costs of regulation are passed on to the consumer in higher prices.

The enormous hidden costs of regulation have been studied by John W. Dawson and John J. Seater in the Journal of Economic Growth. Their examination of the escalation of regulations, as documented in Federal Register since 1949, suggests that economic growth in the U.S. may have been reduced by as much as 2% annually.

Without that drag, the U.S. could be producing over $50 trillion in goods and services instead of its current $17 trillion, and average household monthly income could be four to six times its current $4,400.

Three basics about regulation, politics and the economy must be understood.

  • First, politicians perceive crises as opportunities to grandstand with supposed legislative fixes. But since new laws rarely fix the purported problems, politicians shift responsibility of their laws' rulemaking to unelected, unaccountable agency bureaucrats.
  • Second, regulatory costs are more burdensome for small firms than large enterprises.
  • Third, small companies create most new jobs.

Three major regulatory laws have expanded bureaucratic intrusion the most, having come about with the last two financial crisis-recessions and with restructuring 17% of the economy in health care reform.

The Sarbanes-Oxley law of 2002 was passed in response to the bursting of the dot-com bubble and the failure of Enron and WorldCom, which collapsed into bankruptcy due to fraudulent accounting practices. The SOX law, as it came to be known, created a daunting auditing regime imposed on every area of operations of all publicly listed companies on U.S. exchanges.

It added a minimum of $2 million to annual company costs, which was disproportionately more costly for small public companies and discouraged dynamic private companies from ramping up for IPO funding and stock exchange listing.

The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in response to the 2008 financial collapse. Although failing to fix either "too big to fail" or the Fannie Mae-Freddie Mac duopoly, it did bring unprecedented expansion of power from Washington, rearranging the entire bank and financial-service regulatory chessboard -- empowering new agencies and unelected bureaucrats to rewrite some 400 rules.

Four years later, nearly half those rules remain unfinalized, with 96 of the required rules -- 24% of the total designated -- neglected.

Like SOX, Dodd-Frank created enormous and prolonged regulatory uncertainty -- prompting banks and financial institutions to shift resources and manpower to compliance, lawsuit defense and risk aversion, and away from loan origination and business.

On the heels of Dodd-Frank, President Obama and his party pushed through the Patient Protection and Affordable Care Act -- further expanding Washington's power in the guise of extending social welfare entitlements to provide health care for all. Turns out that ObamaCare and SOX have similar effects -- causing small enterprises to limit growth and cap full-time employees to 49 to avoid costs of mandated health care coverage.

These three laws and their attendant regulatory expansion may have crimped more than 2% growth annually from the present recovery -- thwarting both job gains and wage increases in unprecedented ways for average Americans.

Meanwhile, the Federal Reserve's zero-interest-rate policy of the last five years has made the affluent wealthier, driving liquidity into stocks and hard assets -- lifting prices to levels unwarranted by underlying normalized fundamentals. Here's how it works:

Most public companies reward highly paid executives with stock options and restricted stock, which create incentive to increase their company's stock price by boosting earnings. Even without top-line growth, management can increase per-share earnings through stock buybacks using corporate cash or issuing debt at cheap rates, courtesy of the Fed.

Fed-engineered money creation and low interest rates have helped create a stock market casino, prompting more and more companies to go all in with enlarged stock buyback programs to goose per-share earnings and elevate stock prices -- wealth through financial engineering rather than increased productivity.

Artificially low interest rates have been equally beneficial for real estate investors, providing leverage to propel prices and transactions in an upward trajectory.

While the Fed says its policies have kept consumer prices in check for the working class, the real benefit has been inflating asset prices in the portfolios of the rich. Call them the 1% or the 2%, the rich are getting richer, courtesy of the ruling class in Washington, elected in large part by voters who have been fooled and left behind.

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