Income distribution has become less equal in many countries in recent decades, and prominent economists and politicians have advocated policies that would reverse the change in inequality. Some advocates of greater equality have acknowledged a trade-off between greater equality and higher total income. However, Paul Krugman (2014) and Alan Blinder (2014) have recently denied that there are trade-offs. They argue that efficiency gains from greater equality will also increase total income. Blinder calls the argument a supply- side case for redistribution. They both use the same examples of impoverished families that are too poor to invest enough in food and education for their children. They claim that redistributing income toward poor families would allow investments in children that would increase labor productivity and the total income.
ANTI-POVERTY VS. REDISTRIBUTING INCOME
Productive investments in children could raise total income, but Krugman and Blinder are mixing anti-poverty programs with changes in the distribution of income. Anti-poverty programs raise the incomes of poor families without necessarily lowering incomes of more prosperous families. Raising incomes of poor families can increase investments in their children, but these investments do not depend on a more equal distribution of income. Since the Industrial Revolution, economic growth in many countries has lifted millions of people out of poverty without major harm to groups that were initially more prosperous. More recently, economic reform in China since 1977 has moved millions of Chinese out of poverty without major redistribution of income away from other groups of Chinese. Poverty can be reduced even if the distribution of income remains constant.
EQUAL OPPORTUNITY AND ECONOMIC GROWTH
Krugman and Blinder have not invented a new argument in favor of redistributing income. Instead they are repeating an old, but valid, argument in favor of anti-poverty policies. Because it is difficult to borrow against future labor income, low income parents may be unable to make investments in the health and education of their children that would otherwise be profitable. Policies that provide minimum incomes or safety nets for families can raise total income by increasing equality of opportunity for families. Equal opportunity is important for economic growth but equal result is not. The recent emphasis on income distribution is misleading and possibly counterproductive. The policies of China under Mao Tse Tung are an extreme example of policies intended to produce greater equality of results, that resulted in enormous sacrifices in income and lives. The Soviet Union is another example of an economic system that, under the pretext of greater equality, lowered total income and made most of the population worse off than they otherwise would have been. Economic history has demonstrated that poverty can be reduced as a result of productivity growth, whether the distribution of income becomes more equal, less equal, or is constant.
INCOME SHARE VS. TOTAL INCOME
If the goal is to improve the lives of impoverished people, equal opportunity is more important than equal results. Having a smaller share of a larger total income may be more beneficial to a poor family than a larger share of a smaller income. For example, incomes per capita in 2013 (adjusted for purchasing power) were $54,000 per person in the US and $1,700 in Haiti. If impoverished families earned 20% of the national mean income, they would receive $340 in Haiti and $10,800 in the US. Would an impoverished Haitian be better off with a more equal income distribution that raised his income to the mean income level in Haiti or the opportunity to move to the US and earn only 20% of the US mean? Greater equality in Haiti would result in an income of $1,700, but greater inequality in the U.S. would result in an income of $10,800. The difference between a larger share of a smaller total in Haiti and a smaller share of a larger total in the US is $9,100. Accepting greater inequality would allow substantially more spending on education and health of children. The crucial variable is total family income, not the family’s place in the distribution of total income. Emphasis on distribution is misleading, because economic opportunities of a family depend on how many goods and services it can buy with its total income, not on how income is distributed in a country. It is also clear from the attempts by Haitians to migrate to the U.S. that they are more interested in higher total income and equal opportunity than a more equal distribution of a lower total income.
Achieving higher income per capita and faster economic growth need not result in extremely unequal incomes. Today the general pattern is that the greatest inequality within countries exists in the poorer regions of the world (Tsounta and Osueke 2014.) Using standard measures (Gini coefficients), Latin America has the greatest inequality, followed by Sub-Saharan Africa, the poorest region of the world. Asia (including India and China) has the next greatest inequality, and the greatest equality of income is in the group of high income countries that includes the U.S., Canada, Australia, Japan, and Western Europe. Criticism of the U.S. has focused on greater inequality relative to some European countries, but inequality is greater in poorer countries. Higher income countries have provided greater equality of opportunity to their citizens, which has increased their productivity. Higher productivity is an important determinant of economic growth, and growth allows the reduction of poverty without necessarily redistributing income away from other citizens.
INEQUALITY OF RESULTS
Equality of opportunity is important for poverty reduction, but equality of results is not. To raise incomes, people need opportunities to acquire education and skills, enter occupations, open businesses, and trade freely. The resulting distribution of income will depend on relative wages and salaries that will change in response to changes in relative demands and supplies of skills. The degree of inequality of income will vary with economic conditions. However, in an open and inclusive economy, the degree of inequality will be limited by the ability of workers to acquire skills and enter occupations where rates of return on investments in skills are the greatest.
REDISTRIBUTION AND ZERO-SUM THINKING
Emphasis on redistributing a fixed total income is a narrow perspective that leads to unproductive zero sum thinking. If total income is fixed, low income workers can only gain $1 by taking $1 away from high income workers. One can only gain at the expense of others. However, if one considers a broader range of choices that allows low and high income workers to cooperate by discovering mutually beneficial activities, both low and high income workers can raise their incomes. No one needs to gain at the expense of someone else. Discovering new opportunities to cooperate is the essence of economic growth. Suppose cooperating on a new project would raise low incomes by $1 and raise high incomes by $1.05. Total income and the incomes of both groups would rise, but the distribution of income would become less equal. The project would be rejected if concern about unequal results dominated. Furthermore, if a reduction in cooperation on an existing project would reduce low incomes by $1and and reduce high incomes by $1.05, both groups would be poorer, but income distribution would be more equal. If the goal of more equal income distribution dominates, cooperation would decrease in favor of a poorer, but more equal society. Redistribution is zero sum by definition, and it turns attention away from cooperative policies that reduce poverty through economic growth. Instead it emphasizes the coercion that is necessary to take from one group to give to another. Attempts at redistribution lead to tension, resentment, envy, and accusations of class warfare. Politically, redistribution policies turn people against each other, whereas positive sum policies are consistent with greater cooperation and harmony.
EQUAL PAY ACROSS OCCUPATIONS
Certain policies intended to decrease inequality of results are economically harmful, because they reduce the efficiency of the labor market. Attempts to increase equality of results by imposing more equal wages interferes with the allocative function of the labor market. Shortages of certain skills can be eliminated by higher wages and surpluses can be eliminated by lower wages. If equal wages are imposed, shortages in certain occupations and surpluses in others will persist. Legal minimum wages and government regulation of executive compensation produces disincentives for workers to move to where they are more productive.
RAISING TAX RATES ON THE RICH
Raising tax rates on the rich is a popular proposal intended to reduce inequality of results. However, attempting to “soak the rich” is subject to two limitations. First, some high income workers can move to lower tax domiciles. Saez et al 2014) found high-earning European soccer players to be very responsive to differences in tax rates across countries. He also found that high income workers were highly responsive to lower tax rates offered by a special Danish tax program. The recent exodus of American firms (so-called inversions) to lower tax European countries indicates that corporations are also responsive to differences in tax rates across countries.
Attempts to soak the rich have also resulted in highly complex tax rules. U.S. corporate tax rates are now more than fifteen percentage points higher than in some European countries. American companies have an incentive to spend up to $.15 per dollar to save $1 in taxable income, although the exact gain would vary with exemptions and allowances that vary by country. Their employment of clever lawyers, accountants, and investment bankers to produce legal tax gimmicks is privately profitable and favored by shareholders. However, to the world as a whole, this employment is a deadweight loss. The same bright and imaginative people could have produced useful products instead of playing a game against tax collectors. Tax avoiding gimmicks also produce bitterness and resentment by the public that perceives legal tax avoidance schemes to be cheating or disloyal behavior. Complex tax schemes and loopholes are a direct result of high tax rates in countries seeking to use taxes to produce greater equality of results.
INEQUALITY OF OPPORTUNITY
Changes in inequality of results are difficult to interpret without knowing their source. However, inequality of opportunity is a legitimate economic problem, and reducing it can raise total income and decrease unequal results. Examples of unequal opportunity are policies that exclude people from schooling or other training because of race, ethnicity, religion, or gender. Historically, caste systems and slavery were extreme forms of institutions that denied people equal opportunity. Modern command economies in the Soviet Union and pre-reform China excluded people from certain preferred occupations.
Certain radical groups in Afghanistan and Pakistan have used violence against girls who sought education. Other examples of inequality of opportunity are excluding people from entering businesses in order to protect the monopoly power of favored businesses.
Carlos Slim, the Mexican billionaire, was able to become one of the richest men in the world by effective acquisition of monopoly power. Government failure to provide law and order that allows organized gangs (Mafia) to extort money and goods from businesses and individuals is another example of unequal opportunity. Also corruption involves use of political power to extract money and favors from people with less political clout. Corruption reduces equal opportunity, and it is economically inefficient. It contributes to poverty, and it is most common in the poorest countries in the world, such as Afghanistan and Iraq (see data from Transparency International).
ANTI-POVERTY AS EQUAL OPPORTUNITY
Poverty can contribute to inequality of opportunity by preventing parents from investing in their children’s health and education, as pointed out by Krugman, Blinder, and many earlier writers. This problem can be dealt with by anti-poverty programs that provide a safety net or minimum income for families. Ed Dolan (2014)has recently discussed these issues in this forum. Anti-poverty policies can deal with this issue without resorting to explicit polices of redistributing income.
UNEQUAL OPPORTUNITY, UNEQUAL RESULTS, AND THE DISTRIBUTION OF POLITICAL POWER
Does increasing inequality of income lead to greater political power for the rich that warps the political system in their favor? The political influence of groups is constrained by competition. Rich people are not homogeneous. Some rich individuals donate to the Democratic Party in the United States, others donate to the Republican Party, and some donate to both parties. Wealthy people can be found lobbying on both sides of specific issues. On the Keystone Pipeline, the wealthy Koch brothers spend money promoting the Pipeline, but billionaire Tom Steyer spends his money opposing it. The Obama administration has opposed international corporate mergers that lower business taxes (so-called inversions), but they have received large donations from many business people who gained from inversions. (Bloomberg) In U.S. Congressional elections, candidates that have spent the most money have won most of recent elections, but the direction of causation between spending and winning is unclear. Incumbents have won a very high percentage of elections, and donors like to support winners. Hence, part of the correlation between spending and winning is induced by likely winners inducing donations and spending. Also, the claim that wealthy people can reliably buy elections is questionable. There were a number of prominent recent elections, including the upset of House Majority Leader Eric Cantor, in which the candidate who spent the most money was soundly defeated.
Increased economic inequality has received great attention recently, but it is important to distinguish between inequality of opportunity and inequality of results. Unequal economic opportunity that restricts people’s ability to invest in the health and education of their children is economically harmful, and reducing it can raise total income and reduce poverty. However, increased inequality of results is not necessarily harmful, and certain policies intended to reduce inequality of results can be counterproductive. Higher tax rates can reduce incentives to work, although it is possible to construct minimum income programs with fewer disincentives than current programs. Policies that restrict earnings differences across occupations can lead to inefficiencies in the acquisition of skills. Pro-growth policies are the most effective solution to poverty, and concern about distribution is an unnecessary distraction. At its best, emphasis on income distribution distracts from pro-growth policies that reduce poverty directly. If concern about distribution leads to anti-growth policies, they magnify the poverty problem.
Blinder, Alan. 2014. “The Supply-Side Case for Government Redistribution”. Wall Street Journal, August 15.
Bloomberg News. 2014. “Obama Won’t Return Money from Tax Deals He Dislikes”. August 14.
Dolan, Edwin. 2014. “A Universal Basic Income and Work Incentives: Part 1: Theory. August 18.
Krugman, Paul. 2014. “Time for Trickle Up Economics”. New York Times . August 11.
Saez, Emmanuel. 2014. “Taxes and International Mobility of Talent”. 2014 Number 2. NBER Reporter. August.
Tsounta, Evridiki, and Anayochukwu Osueke. 2014. “What is Behind Latin America’s Declining Income Inequality?” IMF Working Paper WP/14/124, July 2014.