Fair taxes - An income disparity hypothetical

The media chatter about the gap between the wealthiest 1% and the rest of us continues unabated, particularly since the CBO confirmed how much the gap has grown in the last 30 years or so.  We hear some folks talking about taxing the rich, other folks talking about class warfare, but very little real problem solving.  No one I have heard is asking how the gap between the very rich and the rest of us over the last twenty years has affected our economy.

From the little bit of evidence I have seen it appears that in developing economies big income gaps can help generate faster growth, but in developed economy's big income gaps retard growth.

This makes sense to me.  In a developing economy people have a lot more needs than they do money.  So the consumer market is small but bursting with potential to grow rapidly.  Allowing those with an entrepreneurial bent to gather wealth provides capital to pick up the good ideas and run with them.  We are seeing this happening across the parts of the world we have traditionally thought of as undeveloped nations.

But in a developed economy we have more money than needs.  I heard a statistic the other day to the effect that studies show that most people in the United States, once they have about $70,000 a year in household income, don't really want to work longer hours to try to make more money.  I assume $70,000 reflects the point where people have what they need plus some extra, so lets assume $70,000 is the US threshold for a comfortable life.  It is the point where you spend nearly all of your income, but there isn't much you need that you can't afford.  Unlike a developing economy where they need everything, in the developed economy many of us have all we need.

Since economies are mind bogglingly complex, I find a simple hypothetical can help me grasp fundemental relationships quickly.  Here is a little hypothetical about income distribution that popped into my head.

Operating on the assumption the $70,000 figure quoted above is the point where people in the US have their primary wants and needs filled, suppose the net income available to Podunk, a town of 10 people, is $700,000.  If all 10 Podunkians get $70,000 of that income (i.e. no disparity in income) the the full $700,000 of income available to the society is circulating around supporting the economy of Podunk as people spend their income.

But suppose Joe finds a way to take home $200,000 of the $700,000 income in Podunk.  The other 9 persons take home the remaining $500,000 ($55,555 per person, down about $14,500).  Even if Joe has more extravagant wants and needs and spends twice as much, $140,000, as anyone else in Podunk , that still leaves Joe with $60,000 in extra income.  So he looks for somewhere to invest it.  But Podunk now has $60,000 less money in the economy, and the other 9 Podunkians are now $14,500 poorer, so Joe can't start a new business, because there are no Podunk consumers with the money to buy new products.  So what does Joe do?  He probably just pays more to buy up local property.  He inflates the value of some asset local asset without adding any real value.

This sounds really familiar to me.  Stock prices have been inflating and deflating precipitously, but overall for the last 15 years stock prices have spent most of the time at higher valuations than the historical average would suggest were prudent.  Gold prices are inflated, house prices are inflated. In short, we have lots of investment capital scrambling around to make some money, and big corporations sitting on huge piles of money, but few people willing to start new businesses, or expand existing businesses in the US because US consumers don't have the money to support new ventures.  The consumer market in the United States has been shriveled by the wealthiest people taking a bigger and bigger slice of the pie.  We disguised this result for years (and drove the world economy) by consumers taking on a bigger and bigger debt load, but that bubble has also popped.

The chattering political class is all abuzz about job creation, and how can we get people back to work.  I suspect the US is going to be in the economic doldrums until more of the income this country generates starts making it into the hands of the regular folk that spend most of what they earn, and less income goes to the people who have everything they could possibly need or want - except more.