# Is this why the rich keep getting richer?

It’s sometimes said that “the rich get richer, and the poor get poorer” and sometimes, it is true.

Why?

Largely it comes down to knowledge and the law of reinforcement – wealthy people tend to understand finance and tax laws, and they increase their financial skills through habit.

As Aristotle said: “we are what we repeatedly do.”

## At my cricket club, we used to have fundraising raffle draws a couple of times each season

Many of the prizes were often donated by the chap who was well-known as the “rich guy” in the club.

The other members called him, affectionately I think, “Two Jags”, which was the nickname of a British MP who drove two prestige Jaguar cars.

I recall a couple of times fate decreed that “Two Jags” won a raffle prize himself, which always drew a good natured heckle or two: “Money goes to money!” or “re-draw!”.

And, in fact, he usually did simply give the prizes back.

In fact, looking back, the same guy often sponsored the club and its matches and paid for equipment, but rarely did so with any great show.

While many of the playing members grumbled about their match fees of membership fees, the club only really survived thanks to the generosity of a few of the wealthier members.

In an ideal world, countries would work in a similar way.

The wealthy would pay a fair share of tax.

Those in genuine need of benefits and support would be looked after, and so on.

Does it happen in reality?

## Gini

There are certain numbers in economics which you’re never quite sure how are calculated, but can provide a useful measurement guideline.

One such number if the “Gini coefficient”, which is sometimes known as the “Gini ratio”.

Gini is a measure of inequality across a frequency distribution of values, which is one way we can measure inequality in a country: by looking at the statistical distribution of incomes.

In the unlikely event that I come to earn all of the income in Australia leaving income of \$nil for the other 23,057,276 of you, then Australia will have a Gini coefficient of 1.

We will be perfectly unequal!

More’s the pity, this seems to be an unlikely outcome, not least because the government would tax my income and then look to redistribute it elsewhere.

And besides, I’d probably want to spend some of it.

There’s not much point in having all of the money in Australia if I can’t use it!

In theoretical terms, it’s actually possible, although highly unlikely, that the Gini ratio could be greater than one, if some of us had negative income.

At the other end of the scale, if all 23 million of us earned exactly the same income we would be perfectly equal, and Australia’s Gini coefficient would be zero.

In practice, that’s extremely unlikely too.

Even in regimes where equality was seen as an ideal, it rarely eventuates in reality.

Gini ratios can be used to measure other forms of inequality too – of education, for example.

## Gini ratios of the world

When countries go through periods of great change, Gini ratios can move higher – countries become more unequal – as new wealth is created by a minority.

For example, when Britain went through its industrial revolution a new class of capitalists generated great wealth that had previously largely been the preserve of the land-owning nobility.

It’s therefore unsurprising that countries such as China and Brazil, which are countries which have rapidly expanding economies, the Gini ratios are high.

India looks to be heading in a similar direction.

What is perhaps more concerning, is that Gini ratios is developed world countries such as the US and Britain have also increased in recent decades – societies have become more unequal.

In Australia, our ratio has increased too, although we are somewhere ‘in the pack’ when it comes to global inequality.

Gini ratios can sometimes be misleading.

Why?

Because the ratio can rise while the absolute number of people in poverty decreases, and it can be distorted by other factors such as population booms.

It’s also often the case that countries with larger populations can show a greater inequality ratio.

## Why do the rich get richer?

It’s sometimes said that “the rich get richer, and the poor get poorer” and sometimes, it is true.

Why? Largely it comes down to knowledge and the law of reinforcement – wealthy people tend to understand finance and tax laws, and they increase their financial skills through habit.

As Aristotle said: “we are what we repeatedly do.”

One of the reasons that the wealthy have been able to create wealth for the longer term is that they understand how to use the power compounding growth in their favour.

In theory our tax systems are designed to be progressive, in that the wealthy should pay the lion’s share of tax and the wealth of a country should be redistributed fairly.

Unfortunately, it just doesn’t work that way. A theme which we will see developing more and more in coming years is that multinational companies will be increasingly chastised for clever profit-shifting across tax jurisdictions.

With the advent of the internet, it’s harder than ever before for tax authorities to determine where companies should be domiciled and where taxes should become payable.

In Britain, Barclays Bank paid only 2.4% tax on its 2009 global profits, resulting in a group of angry protesters storming one of its London branches.

The bank paid £113m of corporation tax on profits in the UK despite its multi-billion-pound profitability.

And yet, this was legal.

## Tax avoidance is legal; tax evasion is illegal.

It pays to understand the difference.

Wealthy individuals also know how to avoid large tax bills. One way is to acquire quality, income-producing and appreciating assets and then never to sell them.

I recently posted about how Sir James Dyson, a smart bloke who became a billionaire essentially through inventing a purple vacuum cleaner, has bought up £150 million worth of prime British farmland.

Has Sir James suddenly developed a fascination with Lincolnshire sugar beet at the ripe old age of 66? Well, he might have, but somehow I doubt it.

What is much more likely is that Dyson knows that UK farmland is not necessarily liable to incur painful inheritance tax so he may be able to pass on his wealth without the Inland Revenue swiping a large share of his billions.

Better still, prime location British farmland continues to appreciate in value, so the Dyson legacy wins twice over.

Sometimes, money does indeed go to money.

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is a Chartered Accountant, Chartered Secretary and has a Financial Planning Diploma. Using a long term approach to building businesses, investing in equities, & owning a portfolio he achieved financial independence at the age of 33. Visit his blog

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