01/10/2014
Journal of Economic Perspectives, Vol 27 No 3 Summer 2013
This paper starts with the author admitting that the question of what to do about income inequality is tangled up in political philosophy, which is outside the expertise of economists; nevertheless author will engage in it. The opening uses an abstract thought-experiment where a society had perfect income equality, but then an entrepreneur came along to make/sell something that everybody wanted, thereby generating new wealth for herself. This is supposed to "capture, in an extreme and stylized way" (pg22) the US for the past 40 years.
The first major section of the paper asks whether income inequality is somehow inefficient. Author believes that this could be possible if earnings from the top were based on "rent-seeking", but does not believe this is the case. Author does not agree with Stiglitz's argument in The Price of Inequality that rent-seeking is any more prevalent now than it was in the 1970s, though income inequality has risen significantly since then. Author instead uses Goldin & Katz in The Race between Education and Technology to argue that income inequality is due to the stagnation of education while a steady or increasing pace of technology placed a higher premium on skilled labor (pg23). Author does agree that rent-seeking should be limited or reduced if found, though argues that income inequality would be the symptom, not the disease in this case. Author also concedes that the financial industry, while it has a very important role to play in allocating capital and risk, also has socially questionable, unhelpful, or inefficient roles within it (e.g. high frequency trading). In this case, the judgment is that "the vast personal reward may well exceed the social value of what is produced" (pg24).
Continuing on the theme of inequality, author turns to the goal of equality of opportunity. This goal is seen not only as a counterpart to efficiency (unequal opportunity will lead to inefficiency), but also a valuable goal in itself. Stiglitz proposes "intergenerational transmission of income", meaning the same chance that a poor or wealthy child will make it to the top 10% of income earners. Author believes this metric is too simplistic. Author argues that the metric doesn't capture heredity, which likely influences success in life; author concludes from studies that IQ "has a large degree of heritability" (pg25), and so might other character traits and skills. Regardless, author suggests that it is best to focus on raising poor children from bad conditions. Author concludes from personal experience that the opportunities for the children of the 1% are similar to those of the middle class. Setting aside the needed investment in poor children and skilled education, then, is there more to dislike about income inequality? Author then considers it as a negative element of a society in and of itself (pg26).
Author reconstructs the outline of the Okun discussion about the "big tradeoff" between equality and efficiency, and uses Mirless' model for the calculus. In essence, income is a product of effort and productivity, and the government, as social planner with utilitarian goals, skims income using a "leaky bucket" until the effort of the productive income-earners declines to a certain point (pg26-7). This is called the "elasticity of the labor supply" (pg27). Author first doubts this model because "people have different tastes regarding consumption, leisure, and job attributes" (pg27), and uses the example of economics professors that could have taken higher-paying jobs instead. The next section deals with a more profound attack on this model, questioning the government's motivations in acting as a utilitarian social planner. The first point is that there is no interpersonal way to compare utility (yet/at all), and is a common point against utilitarianism. The second point is that utilitarianism is cosmopolitan, not national, though the government doesn't act in such a way to help all people across all nations (pg28). Another argument author has previously leveled, and repeats here, is that if there are character traits that correlate with productivity, those could reasonably be taxed as well. Thus the absurd conclusion that there might well be a utilitarian basis for taxing tall people, men, or other classes of people who have correlations with productivity or success. The final argument seems to grant the Mirless model and even give it the power to observe productivity directly, instead of just observing its product, income = productivity x effort. If one could observe productivity directly, then that could be taxed in itself to equalize consumption, but then, author argues, the most productive would have to work more than everyone else (pg29). This counter-intuitive conclusion is another reductio ad absurdum against utilitarianism.
Author turns to examine the actual arguments made recently by populist movements like Occupy Wall Street and some other books and policy proposals on income inequality. The first is that the tax code isn't progressive. Author: CBO numbers say that it is progressive, "highly" (pg30). The second is that the income that the 1% derive do not reflect their contributions to society, taking CEO pay for an example of cronyism. Author: Given that private equity firms pay CEOs even more than publicly held companies, the charge of cronyism is unlikely. Third: The 1% have benefited from public investment and infrastructure, which they should pay for. Author: this isn't an ability-to-pay argument, it's a get-what-you-pay-for argument, and it seems plausible that the 1% is paying enough; also most taxes go to other individuals, not better infrastructure.
Author concludes with arguing there is a need for an alternative philosophical framework to utilitarianism. Author considers Rawls' original position, but claims it is unintuitive because of the possibility of sacrifices that individuals (now no longer behind the veil of ignorance) would want to make (pg32). As an example, since kidney diseases mean sick people might need donors, it might make sense, while behind the veil of ignorance, to pledge your kidney in return for the assurance that if you got the disease yourself, you would receive one. But no one would want to have their kidney taken against their will, so author argues this undercuts Rawls' theory. Author proposes a "just deserts" theory, which seems to be: everyone gets income based on their productivity and effort (pg32-3).
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