Inequality: The Most Misleading Debate

A couple weeks ago, Rishabh Bhandari wrote a great book review (read it here) on “Winner-Take-All Politics,” a 2011 book explaining the origins, state, and consequences of America’s growing income inequality. In a comment, I pushed Rishabh on a couple of points regarding his article. Rishabh’s reply answered a few of my questions, but provoked me to start a more general discussion about the issue.

Let me begin by noting that Rishabh corrected a mistake I made, by noting that the statistics he provides in the article for income disparity records disposable income, which takes into consideration taxes and transfers.

1. “Fair” Taxation

At the heart of one of the main arguments for combatting income is the premise that there is something inherently unfair about the process of making money in America. That is to say, the argument goes that there are unfair systemic forces that discourage social mobility, stagnate the middle class, and create massive wealth magnets for the top one percent. I actually agree with this criticism – however, what’s truly “unfair” about the American economic system is not primarily our tax system, but our welfare system. A closer look at American welfare policy reveals just how regressive, wasteful, and counterproductive it truly is.

This is not quite true of our tax system. I largely disagree with the criticism that in America today, that “the rich don’t pay their fair share.” This slogan was largely the rallying cry for President Obama’s tax hike on the rich earlier this year and his futile campaign last summer to pass the absolutely trivial “Buffett Rule.” I pointed out in my original comment that in America today, the top quintile (20 percent) of wage earners makes 51% of the total national revenue, but pays a whopping 68 percent of the total federal taxes. That seems like a fair distribution of taxation to me.

Rishabh replied with a political argument: We live in a democracy, and the distribution of income is “fair” if the people believe it’s fair. Right now, the American people have no idea how vast inequality truly is, and are being constantly lied to by politicians whose policies favor the rich. So we should raise taxes to bring down inequality to the levels that are popularly supported.

I agree in principle. We do live in a democracy, so I have no principled opposition to the Congress democratically raising top marginal rates to combat inequality. I just think it’s a stupid policy. But I’m curious – the American people don’t know a lot of things about the financial system. For example, they don’t know how much money certain CEOs and executives make. Should we poll the people and ask them what an “acceptable” income is and set legal limits? What about the cost of land – should the people decide how much we sell our houses for?

These are obviously silly questions, but I think Rishabh’s invocation of democracy does not answer the policy question. Our Constitution refines public opinion through a complex system of separation of powers and checks and balances. This was the defense the founders gave for why we were not overly-democratic and why the people would not have such control over prudential matters like tax rates. So I think Rishabh needs a better normative principle for what “fair” taxes are than opinion polls.

2. Why is there inequality?

This is more of a technical point and I am certainly no expert on this topic. Rishabh quoted the authors of the book in arguing that the chief reason for the rise of income inequality is political corruption. He argued that both the left and the right are in the pocket of Wall Street and big business, which have built elaborate systems of think tanks and PACs to promote a pro-rich people agenda. This seems really wrong to me. If we look at inequality on a global scale, the primary forces at play seem to be globalization and technology. These are changes that have altered the system itself, and are not confined to K street machinations. This is a very important point, but one that I, unfortunately, do not have the necessary knowledge to debate.

3. What’s Wrong with Inequality?

This was the second point I brought up – what is actually wrong with inequality itself? Inequality has been increasing consistently pretty much since people stopped hunting and gathering and started farming. Let’s say you had 10 people in a community. All of a sudden, the richest person’s income doubled. Nobody else’s income changed and they all have enough to live off of – it’s just that the richest person is now even richer. Is the community somehow more unjust now?

Obviously that’s not what’s happened in America, but the thought experiment demonstrates an important point – there’s nothing intrinsically wrong with inequality! Now there are other things associated with inequality that are intrinsic wrongs and should be combatted – inequality of opportunity, poverty, declining social mobility – but these are separate problems from inequality.

Here’s another hypothetical to demonstrate why inequality itself is not the problem. Let’s say we could combat inequality simply by taking away money from the rich. That’s it – no redistribution. Obviously the distribution of wealth or income would become far more equitable. But this is obviously a ridiculous policy – we only support taking away money from the rich if it’s going to help other people. That means that the real objective is to help others, not to combat inequality.

4. The Difference Between “Fighting Poverty” and “Fighting Inequality”

It seems to me that the chief arguments for combating income inequality are that the rich need to pay their fair share and that the poor are struggling and need more help than we are giving them. The first concern I think I have dealt with. The second concern is absolutely critical, and happens to be the issue I am most passionate about. But the way to combat poverty is not by doing simple lump sum transfers from the rich to the poor. The reasons the poor are falling behind is due to related yet wholly distinct forces.

Let me begin by explaining my support for capitalism. I do not have any particular moral attachment to capitalism, I think it is the best system because improves the living conditions of everyone. If capitalism made the rich richer at the expense of the poor, I would oppose it – but that’s not what happens. Capitalism can make the rich massively richer, but also does more than any other system to improve the living conditions of the poor. I don’t need to go all Milton Friedman on this point, but a simple comparison of Hong Kong and mainland China should suffice. So combatting inequality by “changing the rules of the game” i.e. moving away from the capitalist framework will ultimately have the effect of, to paraphrase Margaret Thatcher, “making the poor poorer, so long as the rich are less rich.”

To combat poverty, we should reform welfare. Personally I think Medicaid and Social Security are two of the worst programs in American history, and should be replaced with a simple negative income tax. I think the US government should write a check to every family in need for an amount based on their need.

There is one area Rishabh brings up where I am not sure how to respond. This is in his study of the differing social conditions between the rich and poor in America. A lot of this has been played out in the work of Charles Murray, who has documented how social life is in dramatic decline in poor America. I am unsure which way the causality runs on these issues – does inequality breed

Rishabh raises a good point though about social mobility. There are studies that show this so-called “Gatsby curve” wherein growths in income inequality can lead to a decline in social mobility. But I think we are fooling ourselves to suggest that the cause for weakening social mobility is growing income inequality. Look at the public schools we give to the poor and look at the unbelievably distortionary welfare system we force on them. These are the true culprits for the increasing stratification of American society. We have a welfare system that discourages work and, most importantly, we have a public school system that fails the people who need it the most.

There are lots of problems with the American economic system. We need fundamental tax reform to promote growth and thereby promote employment and wage appreciation. We need welfare reform to stop punishing the poor and institutionalizing a permanent underclass. And most of all we need education reform (starting with universal early childhood education) to provide equal opportunity and to promote social mobility. What we don’t need is to arbitrarily start raising taxes on rich people, as if that will do anything.

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5 Comments

  1. While you raised many excellent questions and I respect your traditional conservative views, I question several of your conclusory statements.

    In your piece, you state, “A closer look at American welfare policy reveals just how regressive, wasteful, and counterproductive it truly is.” In your analysis, however, you never demonstrate any of these points. If in fact the welfare system were “regressive,” then the not-so-poor would be helped more than the truly poor, which is not the case; if the welfare system were wasteful, then the majority of welfare recipients would abuse the system, which is not the case (as many can barely feed themselves); finally, if the welfare system were counterproductive, then gainfully-employed people would abandon their jobs to obtain welfare benefits, which is not the case. There is no doubt that our welfare system needs reform. This is evidenced by periodic abuses of those who subsist on it over their entire lifetimes. Your hallow labels of “regressive,” “wasteful,” and “counterproductive,” however, lend nothing to important and necessary reform discussions.

    Next, you raise the concept of “fair” taxation. Truth be told, who doesn’t want “fair” taxation; it’s a mantra that all those across the political spectrum embrace. But the devil is in the details: what is a fair tax? You never acknowledge that taxes on employment income hover around 50 percent (this figure includes employment taxes), while the tax rate on capital gains is approximately 25 percent. Since the very wealthy experience most of the capital gains, and the not-so-wealthy labor for most of their income, the tax rate dichotomy between the two belies the flawed nature of our tax system.

    You then assert that the primary reasons for income inequality are globalization and technology. While globalization and technology are contributory factors to income inequality, you underestimate the impact that the wealthy have to lobby in Congress. Due to their wealth, the rich can direct legislation to preserve their wealth and thereby perpetuate and enhance wealth inequality. Consider the estate tax. It’s probably the most progressive tax in the entire Internal Revenue Code, historically affecting only the country’s wealthiest 5 percent. In a recent tax bill, due to the extraordinarily lobbying efforts of the wealthy, the estate tax rate has dropped to one of the lowest in its history and the percentage of those who must pay this tax has declined to .1 percent of the nation.

    You also claim that Medicaid and Social Security are “two of the worst programs in American history.” Maybe both these programs need to be reformed, but do you honestly believe our country would be better off without these programs? Given the vast amounts of wealth our modified capitalism has historically produced, we can afford to help the indigent and sick. If we didn’t do so, the consequences would be dire as both programs have stabilized the social fabric of our country and stopped scenes of the elderly and sick dying in the streets. You state that you feel “the US government should write a check to every family in need for an amount based on their need.” For such an advocate of capitalism, this proposal does not seem capitalistic at all. Not to mention, that “check” could then be used for drugs or to support other harmful habits, and it would be very difficult to monitor such spending habits.

    The piece concludes by you declaring your support for capitalism. Never once, though, do you actually show how capitalism improves “the living conditions of the poor,” nor do you acknowledge that we do not live in a purely capitalist country but rather a modified capitalist system. I would argue that with more “pure” capitalism, there would be a greater chance of populist insurrections (particularly, as monopolies and oligopolies multiplied and controlled numerous components of the country).

    There are many parts of the American economic system that need to be reformed. But reform measures must be carefully considered and analyzed. Name-calling and hollow labels serve no one’s interest, and I’d like to ask you to offer more substance to what may prove to be very sensible ideas.

  2. I’ll respond to your criticisms point by point.

    1. You’re right, I didn’t talk about specific problems with the welfare system because that wasn’t the intent of the piece. My piece was trying to show that inequality is the wrong thing to focus on, not to go through various programs and explain why they are bad. But since you asked, I’ll give some examples. For instance social security and medicare are funded by payroll taxes, which are highly regressive as poor people pay a higher percentage of their income than do wealthy people. Any means tested program will have a “cliff” at which point increasing income will lead to a decrease in benefits. A lot of these programs are designed so poorly that there is simply no financial incentive to increase one’s income. I’ll point you to a couple of articles that bear this out. This presentation explains the role of the “cliffs” in discouraging upward economic mobility (http://www.aei.org/files/2012/07/11/-alexander-presentation_10063532278.pdf) in particular look at this slide (http://1.bp.blogspot.com/-_-6Fsycanmw/ULO_5kk3fxI/AAAAAAAAAU4/y1PbUElDS34/s1600/marginal-tax_6.PNG) which shows that a single mom is better off 29,000 dollars than she is with a gross income of 69,000 dollars.

    The larger point is that most of our welfare programs fall victim to something called “Director’s Law,” which maintains that most welfare programs subsidize the middle class at the expense of the rich and poor. Obviously this doesn’t cover all programs, but it is a very powerful critique of modern statism.

    I stand by my characterizations that the system is “regressive” (look at the payroll tax), “wasteful” (look at social security disability for example), and “counterproductive” (look at the financial disincentives captured in the two links I sent). There are further problems with the tax code, which have distortionary deductions that favor rich people. I can send articles bearing that claim out, but I don’t want to spend more time on this point.

    2. You’re again right on the point about “fair taxation” – the devil’s in the details. The stats you gave are misleading though, because there are more federal taxes than just income and capital gains. So yes, capital gains taxes are lower than income taxes, but people who pay capital gains taxes have already indirectly paid corporate taxes (which are really, really bad) and then double pay when they pay taxes on dividends. That’s why the statistic I gave is, I think, the most useful. It’s helpful to look at “who makes all the money” and compare it to “who pays all the taxes.” If you look at supplementary table 6 in the CBO link I included in the original (http://www.cbo.gov/publication/43373) it shows that the income figures it uses includes capital gains. So to repeat the finding – the top quintile makes 50% of the money (including income and capital gains) and pays 67% of all federal taxes (including income, capital gains, payroll etc…)

    To be clear I hate the current tax system. I think we should get rid of half the loopholes and deductions and ideally move to a consumption tax (with a negative income tax welfare side to correct for regressive unintended consequences – I will discuss this later). Maybe the system should be more progressive, but I haven’t seen a particularly compelling argument why yet.

    3. I don’t know of any statistics that show that the reason for increased inequality is lobbying. Take for example the estate tax, which you bring up. It represents a very small fraction of the revenue the government makes and is not a significant causal factor for the growth of inequality. (that’s speculation, I don’t have stats). As I mentioned in my article, I do not know nearly enough to be able to argue about this intelligently, but I will say that it is intuitive to me at least that globalization and technology explain the massive increase in income inequality. It’s not really productive to argue about this without empirics, and I don’t have any.

    4. No I don’t think America would be better off if we didn’t have Medicaid and social security. I still think they are really bad programs. I’ve explained some of my problems with welfare earlier, but there is obviously much, much more that is wrong with these programs.

    To be clear, here is my position. I have no *principle* opposition to redistribution. I support redistributing money, through taxes and welfare, to support poor people. I have *prudential* opposition to our existing welfare system, which is regressive and counterproductive. I don’t know if you want me to argue specifically about Medicaid and social security, but I think the empirical evidence speaks for itself that these programs are just bad. I think everyone should agree with me on the payroll tax, for example, which is the stupidest tax on the books. Also, why isn’t social security means tested? Why do millionaire old people get unlimited access to healthcare on the public dime? That sounds really stupid too.

    As for my own welfare program of choice, I think the “negative income tax” is the most efficient way, moving forward, to reform redistribution. You charge that it’s anti-capitalist, but the greatest advocates for the NIT in history have been Margaret Thatcher and Milton Friedman, so that hardly seems like a reasonable criticism. The problem with the current welfare system is that it is overly bureaucratic, wasteful, at times regressive, and at times insulting. The common criticism against the NIT which you suggested is that “poor people will buy the wrong things,” which I think is not a claim that is borne out in the social science. Giving people checks can be the most efficient way for them to invest and save for their own future success. Yes there are some things that the government should guarantee even if the individual doesn’t choose to buy it (emergency health coverage, for example), but by in large, I trust individuals to be more responsible with their own money than I trust government to be. (that’s not a conspiratorial concern, just a pragmatic one).

    5. I didn’t talk much about my empirical claims about capitalism because I would assume the facts speak for themselves. Capitalism improves the wellbeing of all people in absolute terms better than any other system. Compare Hong Kong v. Canton, South Korea v. North Korea, West Germany v. East Germany. Note I am not simply making a laissez-fairre or nothing argument. I think there should be all sorts of government subsidies/regulations/reforms that redistribute wealth and protect individuals from abuse. I’m not a libertarian on these issues. This probably makes this final criticism perhaps a bit of a strawman of Rishabh’s argument, because on philosophic grounds Rishabh and I probably agree a good deal on the appropriate role of government.

    The criticism was more targeted against Occupy Wall Street, throw out the system radicals who blame capitalism itself for all our social and economic ills. I agree with many critics that capitalism has a lot of problems and is not a moral philosophy. I support capitalism because it works and makes people’s lives better. Which is why the poor in America still live better than does the vast majority of humanity, and why the poor in America even live better than the rich in 6 OECD countries (http://www.economist.com/blogs/graphicdetail/2013/05/daily-chart-17?Fsrc=scn%2Fgp%2Fwl%2Fdc%2Fbetterlifeindex)

    I agree that the wealthier America gets the more obligations it has to its people, but we really should try to keep things in perspective here.

    Given all that, I still maintain that the number one cause of an overwhelming amount of our social, economic, and cultural malaise is our disgraceful public education system. That’s what needs to be completely overhauled if we are to address these serious problems.

  3. Dimitri, thank you very much for your prompt response and analysis. I still disagree with many of your points, but I appreciate that you offered specific examples and cogently defended your arguments. There is no need to belabor points we’ve already made, and so I will prevent myself from rebutting your rebuttal.

    However, I would like to address something in your comment that I did not touch upon in my earlier comment, and that is the public education system. To claim that our public education system is disgraceful and the number one cause of our “social, economic, and culture malaise” is troublesome. I, for one, attended a public school that caters to low- and middle-income earning families in New Jersey and am truly grateful for all that my school offered me. I agree that in some states, the public education system requires reform, but to indict our entire public education system is suspect. The fact that every citizen in our country can attend his or her town’s schools through 12th grade without paying a dime (extra to property taxes) is something that millions of impoverished people around the world look upon with enormous envy. Before you jump to such a bold conclusion about how disgraceful our public education system is, I would take a step back and recognize how lucky we are to live in a country where the public schools are what they are. Without public education, most of America’s youth would not be able to have an education. The educational system in many states may need to be reformed, but it is an unparalleled system that has allowed millions – who otherwise wouldn’t have been able to – to attend school and have access to tremendous opportunities.

    1. I agree that compulsory public education was one of America’s greatest achievements and I agree that we should often be thankful to live in a country as prosperous as America. Public education is better than having no public education, but it still is in crisis that needs to be addressed. You used similar thinking in discussing medicare and social security. I’m not presenting a dichotomy between “public education” and “no public education,” but that doesn’t mean the system is almost a complete failure at this point (with some notable exceptions).

      I also don’t quite know what you mean by calling it an “unparalleled system.” Clearly many countries that are much poorer than we are have far superior education systems. We should try to learn from their examples

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