August 22, 2011
Income Inequality and Envy
Income Inequality and Envy—Posner
The position one occupies in the distribution of income and health is largely a matter of luck—the luck of the genes, the social and economic standing of one's parents, accidents of upbringing, the match between one's abilities and demand for particular goods and services, and so forth—though there is an element of choice, since people are motivated by nonpecuniary as well as pecuniary factors. But that is more a matter of some people who could earn high incomes choosing a career less remunerative but more productive of nonpecuniary income. A person who lacks the ingredients of financial success can "choose" to become rich but won't get anywhere.
Utilitarians believe that, other things being equal, income equality maximizes utility because of the diminishing value of income—an extra $100 confers more utility on a beggar than on a millionaire. So utilitarians are apt to condone inequality only if it increases average incomes substantially—which doubtless it does, within limits at any rate, at least in a society not riven by envy. (In highly envious cultures, a person may start a fire that will destroy both his and his neighbor's barn, provided his neighbor's barn is worth than his and is not insured.)
Hence Becker properly emphasizes the importance of distinguishing between economic inequality that promotes, and economic inequality that retards, the creation of social wealth. And in a commercial society such as that of the United States, a political-economic system that allows able people to make and keep large fortunes produces powerful incentives to create wealth. I call the wealth they create "social" because it benefits other than just the creator of the wealth. Successful producers of goods and services create consumer surplus and pay a disproportionate share of taxes.
That is not to say that the income of wealthy people is carefully proportioned to their contribution to social wealth. A person who wins a fortune in a lottery does not increase the size of the economic pie, but merely gets a big slice for himself. But lotteries are an effective method of tax collection (they are voluntary taxes), and windfalls are an essential element of the method and therefore have a legitimate social function.
These points are not familiar to the general public, so it is a puzzle why there is so little envy in our society. There is of course local envy—envy of a neighbor or coworker who one thinks has enjoyed undeserved good fortune—but that is different from envy of the rich as a class. Inequality has grown significantly in recent decades and has been magnified and dramatized by the continuing economic crisis; high un- and underemployment coexists with widely publicized lavish partying by billionaires. One reason for the lack of envy is that the only inequality that is noticed is inequality between middle and upper class people—the poor are invisible—and the middle class is well off by international and historical standards. Another reason is that there is already a good deal of redistribution of income and wealth through the entitlements programs, and further redistribution, involving significantly heavier taxes, is generally opposed, as no one knows whom the burden of the heavier taxes will actually fall on. Still another factor is the domination of campaign financing by the wealthy, which discourages legislators from left as well as right from waging "class warfare." Also, America is a classless society in the sense that the wealthy do not flaunt a superiority of culture or manners (think of the vulgarity of a Donald Trump); they do not, typically, attend the very best prep schools and colleges; they are not, for the most part, rentiers, living off inherited wealth; they are not considered "better" than other people; they just have more money. And America remains an open society. Children of privilege have advantages, but the talented who start with no advantages face no obstacles to rising.
Equality of opportunity, a salient American cultural characteristic, actually guarantees inequality of income, because an opportunity is just a chance. Equality of opportunity is related to individualism and competitiveness, which are also American traits, related to the diverse origins of its large population. Ties of community are loose, and altruism outside the family circle limited.
Inequality could reach a point at which a relatively small group controlled such a large fraction of the nation's wealth that a political movement could rally support for dispossessing them of their wealth. At present, however, such a movement does not exist.
Deserving and Undeserving Inequality–Becker
During the past 25 years, inequality in the world has greatly declined mainly because of the rapid growth in incomes in large poorer nations, especially China, India, and Brazil. This led to enormous declines in worldwide poverty as hundreds of millions of families were pulled above poverty thresholds, such as having to live on $1 or $2 dollars a day. At the same time, however, inequality between families grew rapidly within many countries, especially the United States and other Anglo-Saxon countries, China, and India. Although attitudes to inequality differ across cultures and countries (see, for example Alesina, Di Tella, and MacCulloch, "Inequality and Happiness: are Europeans and Americans different?"), in every society these attitudes depend on whether the inequality is considered to improve efficiency and to be deserving – the difference between "good" and "bad" inequality.
The great majority of people in different cultures do not object to someone who has made lots of money when they have superior abilities and talents, and they work hard at producing what are considered useful goods or services. Actors like Tom Hanks or Jennifer Aniston earn millions of dollars per film, yet they are admired as stars rather than condemned for being millionaires because films are a popular form of entertainment. Bill Gates, Steve Jobs, and others who became billionaires by creating innovative companies that provide highly valuable goods and services to millions of individuals are widely admired as the business equivalents of rock stars rather than attacked for their great wealth. Leading transplant and other doctors who become successful and very wealthy through extensive education and superior skills are recognized for their valuable contributions to extending the lives of very sick individuals, and few object to their high earnings.
On the other hand, when hedge fund managers become rich by using arbitrage activities to narrow the spreads in interest rates and other prices between different regions (most hedge funds do not only engage in arbitrage) they produce useful services, but the value of what they do is not so apparent as the businessmen who make successful products. It is still harder for many to understand the usefulness of "speculators" who do well financially by successfully shorting shares of companies or commodities, such as oil, because they believe correctly that their prices will fall in the future. Their activities add value by smoothing out the prices of these shares and commodities over time, but few people like individuals who bring bad news, or who profit from anticipating bad news.
Other forms of behavior are objectionable because they both add to inequality and lower economic efficiency. These are the most dangerous sources of inequality, and they create negative attitudes toward the wealthy, and even at times social unrest. One illustration is the arbitrary use of government power to give or take away wealth. Some individuals become very wealthy because of the political favors they receive, while others lose much of their wealth because of unjust governmental treatment. Examples include Carlos Slim and the Russian oligarchs who gained big economic advantages by receiving monopoly positions in industries like telecommunications when they were privatized, and the officials of Fannie Mae and Freddie Mac who became wealthy by using their political connections to acquire a dominant position in the US residential mortgage market. A highly publicized recent example is the Indian businessmen who obtained special privileges in telecommunications and other industries because of corrupt government officials.
Arbitrary taking of property through eminent domain and other government power without proper compensation is a major source of discontent. Chinese farmers objected, and some even rioted, when governments took their land to build infrastructure or factories. Governments in the United States sometimes use eminent domain powers to take the land and housing of families in order to build public and private redevelopment projects. In these and related examples, people object partly to the forced transfers of property to governments, and partly to inadequate compensation to small property owners, at least inadequate in the eyes of those losing their properties and their neighbors.
Since earnings is the biggest contributor to income for the great majority of families, the considerable inequality in earnings has been extensively dissected. During the past several decades, technological advances that favored highly skilled workers raised the earnings of college graduates by a lot relative to those with lesser education in the United States, Great Britain, China, India, and many other countries. This sharply higher relative earnings of the more educated has been accepted for the most part since it contributes to greater productivity. Criticized are the various obstacles that prevent able boys and girls from acquiring a college education, such as broken and poor families, and inadequate schools. These obstacles lead to bad and inefficient inequality that sometimes causes frustration and discontent among those affected.
Attractive public policies encourage the good earnings inequality and attack the bad inequality through laws, taxes and subsidies, and in other ways. For example, charter schools, vouchers, merit pay for good teachers, Head Start programs, and student loans help more able students from disadvantaged backgrounds enter and finish college.
Public policies can also help overcome inefficient sources of inequality in other types of income, although these policies often run into powerful political opposition. Privatization and other sales of government properties should be auctioned off, not given away to favored businessmen. Governments should be allowed to use eminent domain and similar laws to take property from individuals only in sharply constrained circumstances with very high benefit/cost ratios. Regulations should be based on rules rather than discretion, so that the regulators cannot easily get "captured" by the industries they are regulating, including capture through corruption of government officials.
I agree with the argument by Warren Buffet in a recent New York Times op-ed piece that it is neither fair nor efficient for highly wealthy individuals like himself to be paying a smaller fraction of their incomes in taxes than middle income and many lower income persons. However, the way that inequity is corrected can make an enormous difference to economic efficiency as well as to the degree of inequality. The best way to reduce these inequities is to substitute for the present tax mess an inclusive equal percentage tax on all incomes, where the income base would be greatly widened by eliminating deductions on mortgage interest payments, restraining the tax-deductibility of charitable contributions, and eliminating special subsidies, such as the generous ones to ethanol producers. With a flat broad equal percent tax on all incomes, capital gains and other sources of income that currently have special tax treatment should then be taxed at the same flat rate as earnings and other incomes.