You cannot
make the poor richer by making the rich poorer.
One month
into the second term of the Obama administration, the economic prognosis looks
mixed at best. On growth, the U.S. Department of Commerce reports the last quarter of 2012 produced a small decline in gross domestic
product, without any prospects for a quick reversal. On income inequality, the
most recent statistics (which only go through 2011) focus on the top 1 percent.
“Incomes
Flat in Recovery, But Not for the 1%” reports Annie Lawrey of the New York Times. Relying on a recent report
prepared by the well-known economist Professor Emmanuel Saez, who is the director for the Center
of Equitable Growth at Berkeley, Lawrey reports that the income of the top 1
percent has increased by 11.2 percent, while the overall income of the rest of
the population has decreased slightly by 0.4 percent.
Growth vs. Equality
What
should we make of these numbers? One approach is to stress the increase in
wealth inequality, deploring the gains of the top 1 percent while lamenting the
decline in the income of the remainder of the population. But this approach is
only half right. We should be uneasy about any and all income declines, period.
But, by the same token, we should collectively be pleased by increases in
income at the top, so long as they were not caused by taking, whether through
taxation or regulation, from individuals at the bottom.
This
conclusion rests on the notion of a Pareto improvement, which favors any
changes in overall utility or wealth that make at least one person better off
without making anyone else worse off. By that measure, there would be an
unambiguous social improvement if the income of the wealthy went up by 100
percent so long as the income of those at the bottom end did not, as a consequence,
go down. That same measure would, of course, applaud gains in the income of the
99 percent so long as the income of the top 1 percent did not fall either.
This line
of thought is quite alien to thinkers like Saez, who view the excessive concentration
of income as a harm even if it results from a Pareto improvement. Any center
for “equitable growth” has to pay as much attention to the first constraint as
it does to the second. Under Saez’s view of equity, it is better to narrow the
gap between the top and the bottom than to increase the overall wealth.
To see the
limits of this reasoning, consider two hypothetical scenarios. In the first, 99
percent of the population has an average income of $10 and the top 1 percent
has an income of $100. In the second, we increase the income gap. Now, the 99
percent earn $12 and the top 1 percent earns $130. Which scenario is better?
This
hypothetical comparison captures several key points. First, everyone is better off with the second
distribution of wealth than with the first—a clear Pareto improvement. Second,
the gap between the rich and the poor in the second distribution is greater in
both absolute and relative terms.
The stark
challenge to ardent egalitarians is explaining why anyone should prefer the
first distribution to the second. Many will argue for some intermediate
solution. But how much wealth are they prepared to sacrifice for the sake of
equality? Beyond that, they will have a hard time finding a political mechanism
that could achieve a greater measure of equality and a program of equitable
growth. The public choice problems, which arise from self-interested intrigue
in the political arena, are hard to crack.
These
unresolved tensions are revealed by looking at a passage from Saez’s report Striking it Richer. Saez is largely indifferent
to these problems of implementation when he observes ominously that
falls in income concentration due to economic downturns are temporary unless drastic regulation and tax policy changes are implemented and prevent income concentration from bouncing back. Such policy changes took place after the Great Depression during the New Deal and permanently reduced income concentration until the 1970s. In contrast, recent downturns, such as the 2001 recession, lead to only very temporary drops in income concentration.
The policy changes that are taking place coming out of the Great Recession (financial regulation and top tax rate increase in 2013) are not negligible but they are modest relative to the policy changes that took place coming out of the Great Depression. Therefore, it seems unlikely that US income concentration will fall much in the coming years.
Let’s
unpack this. It is surely true that the top 1 percent (or at least the top 1
percent of that 1 percent) is heavily invested in financial instruments, and
thus will suffer a decline in income with the regulation of the financial
markets. But by the same token, it would be absurd to praise any declines in
overall capital wealth because of its supposed contribution to greater equality
for all individuals. Nor would it make any sense to describe, as Saez does, the
current situation as one of “booming stock-prices” when the Dow Jones
Industrial Average still teeters below its 2007 high. Take into account
inflation and one finds that the real capital stock of the United States has
actually declined over the last six years, which reduces the wealth available
to create private sector jobs.
Nor,
moreover, is there anything permanent about the 2012 gain in income at the top.
As Saez himself notes, some portion of the recent income surge has resulted
from a “re-timing of income,” by which high-income taxpayers accelerate income
to 2012 to avoid the higher 2013 tax rates. Accordingly, we can expect that
real incomes at the top will be lower in 2013 than otherwise would have been
the case. Indeed, it is possible that these “modestly” higher taxes could
produce the worst of both worlds, by depressing government revenues and reducing the income of the
rich.
Saez’s own
qualification is best read as a backhanded recognition of the perverse
incentives that rapid changes in the tax structure create. It is a pity that he
does not go one step further to accept the sound position that low, flat, and
steady tax rates offer the only way—the only equitable way—to sustainable
overall growth.
A Return to the New Deal?
Unfortunately,
Saez would rather move our system precisely in the opposite direction. He
praises the dramatic shifts that took place during the Great Depression, when
marginal tax rates at the federal level reached 62 percent under Hoover’s
Revenue Act of 1932, and stayed high during Roosevelt’s New Deal period. The anemic economic performance of the Roosevelt New Deal arose
in large part from a combination of high taxation and destructive national
policies that strangled free trade, increased union power, and reduced overall
agricultural production. Today, Saez concentrates on the income growth of the
top 1 percent. He does not address the feeble levels of economic growth over
the last five years.
Saez may
think that the latest round of tax increases and financial regulations are
“modest” in the grand scheme of things. But their effects have been
predictable. The declines in productivity have translated into lower levels of
income and well-being for all affected groups.
The blunt
truth remains that any government-mandated leveling in society will be a
leveling down. There is no sustainable way
to make the poor richer by making the rich poorer. But increased regulation and
taxation will make both groups poorer. Negative growth hardly becomes equitable
if a larger fraction of the decline is concentrated at the top earners.
The Middle Class and the Minimum Wage
The effort
to promote equitable growth at the expense of the top 1 percent has serious
consequences for current policy. It is no accident that in his recent State of the Union Address, President Obama once again called
for increases in taxes on “the wealthiest and the most powerful.” If adopted,
these changes would make the tax system more progressive and the economy more
sluggish.
Indeed the
President goes further. He pushes for the adoption of other wrong-headed
policies that would also hurt the very people whom they are intended to help.
Consider that the Lowrey story featured a picture of President Obama appearing
before a crowd at the Linamar Corporation in Arden, N.C., seeking to make good
on his promise to raise the minimum wage to $9.00—to advance, of course, the
interests of the middle class to whom the President pays undying allegiance.
The
President thinks he can redistribute income without stifling economic growth.
The simple rules of supply and demand dictate that any increase in the minimum
wage that expands the gap between the market wage and the statutory wage will
increase the level of unemployment. The jobs that potential employees
desperately need will disappear from the marketplace. In a weak economy, a jump
in the minimum wage is likely, as the Wall Street Journal has noted, to reduce total jobs,
with unskilled minority workers bearing the brunt of the losses.
Unfortunately,
the President displays his resolute economic ignorance by proclaiming,
“Employers may get a more stable workforce due to reduced turnover and
increased productivity.” But they can get that stability benefit unilaterally,
without new legislation that throttles other employers for whom the proposition
is false. Only higher productivity secures long-term higher wages.
Indeed,
the best thing the President could do is to just get out of the way. After over
four years of his failed policies, Mortimer Zuckerman reports that unemployment rates still hover
at 8 percent, and 6.4 million fewer people have jobs today than in 2007. That’s
an overall jobs decline of 4.9 percent in the face of a population growth of
12.5 million people from July 2007 to July of 2012. The same period has
registered sharp increases in the number of people on disability insurance (to
11 million people) and food stamps (to some 48 million).
There is a
deep irony in all of these dismal consequences. The President’s State of the
Union Address targeted the plight of the middle class. That appeal always makes
political sense—but it also makes for horrific economic policy. All too often,
the calls for equitable growth yield anything but the desired outcome.
Richard A. Epstein, the Peter and Kirsten Bedford Senior Fellow at the Hoover Institution, is the Laurence A. Tisch Professor of Law, New York University Law School, and a senior lecturer at the University of Chicago.
4 comments:
This is nothing but the diatribe of failing logic. Even those bastions of market based economy - the right-wing instiutions of the World Bank and IMF - have agreed, finally, that inequality is a massive issue which effects countries, especially in terms of social cost (which effects everyone). There is acceptance that the "growth at all costs" political ideology is coming to an end. It will just take some longer to realise this than others. After all, being brainwashed for the past 50 years will take time to undo.
Paul Harris, your comments are callow and yet delightfully comical. Can you please explain what "failing" logic means? Perhaps you meant to say illogical, in which case you should advise us as to the specific components of the discourse which are illogical.
All economies in the usual sense of the word are "market based" - one presumes you meant to say free market or laissez-faire? Although it is not explicitly stated one would also presume that you advise a command economy over a voluntary one? Both the right wing and the left wing tend to favour market interference so probably better to talk in terms of how much interference is being enforced.
The World Bank and IMF are not necessarily friends of the free market raising concerns that you may not understand what a free market is (hint: no player has special legislation).
"Social cost" is a meaningless concept unless you explain exactly what it refers to. Social has been tacked onto an increasing array of words to obfuscate a precise definition and has no place in serious discussion.
Government statistics about "inequality" are fairly meaningless unless you are interested in using the information to change the situation by coercion. And if coercion is employed it simply involves the transfer of wealth (as the government measures it i.e. money) from the "givers" to the favoured. No government or otherwise can measure the status an individual; the innumerable factors that contribute to the human condition. It is somewhat ironic that the socialists are so heavily focussed on getting the money into their pockets that they appear oblivious to all the important aspects of life that can never be measured.
Warren Buffett has complained that he is paying tax at 8.5% whilst his clerical staff pay tax at some 22% (E.& O.E.). At least Warren paid tax. One wealthy American skited that "only the little people pay tax"! I agree with the thrust of the article, but with FAIR taxation, for goodness sake.
Jonathan Spink
Richard Epstein is an adjunct scholar for The Cato Institute, an American libertarian think tank headquartered in Washington, D.C. It was founded as the Charles Koch Foundation in 1974. Enough said?
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