Income inequality

My seminar students are untroubled by the increase in income inequality in the U.S. over the last three or four decades. The evidence we have seen in class – most importantly, that only the top ten percent of the income distribution has seen its real compensation rise at or above the rate of growth of aggregate productivity while the bottom ninety percent have seen their compensation rise at a slower rate, and that by a couple of different measures there is less income mobility in the U.S. than in other industrialized countries – does not surprise or bother them. If pressed, I think most (maybe all) of them would agree with Martin Feldstein’s argument that we have no cause to be concerned if the richest members of society grow richer as long as the poor are not made poorer in the process. To oppose the rich getting richer, per se, is “spiteful egalitarianism.”

My efforts in class at making the case against inequality have been rather feeble, so perhaps it will help to lay it out here. I don’t pretend to approach this issue with any sophistication. I’m not well-versed in the philosophical debates concerning inequality that have been carried out for centuries – I can’t speak authoritatively about utilitarianism versus Rawls’ veil of ignorance versus the categorical imperative versus the golden rule versus a chicken in every pot. I’m a practical man, with practical reasons for being concerned about the widening distribution of income. Here they are.

The first reason is rooted in morality or, if you will, my sense of the requirements of social justice. If I were to set myself the task of designing the groundrules for a just society – to take on the task of Burke, or Locke, or the Founding Fathers – I would start from the notion that the just society strikes a balance between two basic moral principles. One, that individuals have the right to pursue their own interests and to secure the proceeds of their own efforts, and two, that the social order must provide benefits that are widely distributed across the population. For Feldstein the second principle boils down to the idea that the wealth-accumulating efforts of the most energetic in society can be constrained only insofar as it is necessary to keep the poorest members of society out of abject poverty. I go quite a bit further. Poverty is a relative concept – the psychological pain of poverty is a function not of the absolute standard of living but of the difference between the standard of living of those in poverty and the standard of living of the typical (let’s say median) individual or household. I see a moral justification for narrowing the distribution of income between the bottom and the middle. As a practical matter, this means taxing (explicitly or implicitly) those at the very top of the distribution and transferring “their” income to the bottom (explicitly or implicitly) through something like the earned income tax credit, the minimum wage, laws protecting the rights of workers to unionize, and public spending on health care, parks, libraries, museums and schools. The result will be that the rich in my ideal society will earn less than their marginal product and the poor will earn more. I justify this on moral grounds, but if you ask me to approach the matter as an economist I will tell you that there is a vast stock of social capital to which everyone in society contributes, and that the earnings of the very rich and very poor do not reflect the contribution of this social capital to production. There is an externality, in other words, that inflates the earnings of the rich while deflating the earnings of the poor, and the proper (Pigovian) solution is to offset the externality by a tax and subsidy scheme.

Most of my students, I think, would argue that we need to seek “equality of opportunity” rather than “equality of outcomes,” which is what my second principle concerns. Freedom includes the freedom to fail, it is said; as long as everyone gets a fair shot at the brass ring, it shouldn’t concern us if some fall on their faces in the effort to grasp it. My response is first that while it is inevitable that some will fall on their faces, we as a society can ensure that there is a rubber mat below them rather than a slab of concrete. And second, I think that in the present circumstances the inequality of outcomes that we observe reflects and is caused by a fundamental inequality of opportunity that is too often unacknowledged. The advantages that come from being born and raised in the top, say, 20% of the income distribution are innumerable. Some are inevitable – genetics, more attentive parenting, role modeling – and cannot or should not be offset by social policy. But others – access to good schools, good health care, good nutrition, and social networks – amount to an unjust advantage over the rest of society for which it is the proper object of social policy to attempt to correct. I’ve had many students who do o.k. in classes – though competent they don’t show great natural ability – who by virtue of their place in society have opportunities that are unavailable to the majority of 18-22 year olds, even those with tremendous natural ability. Just attending a college like Gettysburg, for an obvious starter, but also things like internships (“Dad works for Citigroup, so I’ve got an internship there for the summer”), alumni connections, ability to exploit their parents’ connections, and so on. My students may convince themselves that the success they achieve in life is due to their own hard work (and some of them do work very hard), but they underestimate, I think, the portion of their success that is due to the advantages that accrue to their social class. My just society does not let these advantages (which by necessity impose a corresponding disadvantage on those not born to privilege) stand, and therefore I support programs like affirmative action that mandate hiring procedures intended to broaden the pool of applicants and ensure that every applicant is judged against a common standard. I also support the estate tax, which puts a limit (though a very generous one) on the extent to which one generation can live off the hard work and good luck of the previous one.

It also seems to me that a big part of the widening distribution of income is a result of behavior on the part of the wealthy that produces no social benefit and in some cases may produce great social harm. Corporate executives have been fantastically successful at claiming for themselves an outsized chunk of company revenues. To the extent that corporate compensation reflects insider deals and incestuous relationships between executives, corporate boards, and outside consultants, executives are in effect stealing from shareholders, workers, and customers. The explosion in executive compensation, I believe, is the result of a gigantic principal-agent problem that is at the same time creating inefficiencies in capital markets and distorting the flow of investment. Legislation that would restrain the behavior of executives (mandating truly independent boards, shareholder rights, expensing of options, etc.) would take away some of the income gains of those at the very top of the income distribution while increasing the efficiency of financial markets and the corporate sector. Other big winners in our economy likewise are engaged in untrammeled rent-seeking that does not necessarily produce proportionate social benefits. Lawyers that make gajillions from patent-infringement lawsuits, the Jack Abramoffs of the world who trade on connections to feather the nests of well-heeled businesses, land speculators who profit off of inside information about where the next highway is going to be located. A new book by Dean Baker makes the case that many of our economy’s winners owe their success to specific anti-market legislation: the retroactive extension of copyright protection for companies like Disney, for example; doctors who are insulated from competition from highly skilled immigrants; oil company or agribusiness shareholders and executives who benefit from a myriad of government subsidies. Now we could take a hard look at each of these individual cases and try to address each one through narrowly targeted legislation; but we might never track down all of the ill-gotten and inefficient sources of wealth of the very rich, and so the next best thing may be a steeply progressive income tax. We’ll confiscate the ill-gotten gains and hope that the Bill Gateses and Warren Buffetts of the world, whose earnings are arguably in rough proportion to their contributions to the economy, don’t dramatically alter their behavior because the IRS taxes their second hundred million at a higher rate than their first.

I also believe that an egregiously unequal distribution of income is damaging to democracy. A democratic society is one in which people from all walks of life are able to come together, identify common interests, and cooperate in common endeavors. Taking actions to protect ourselves against terrorism, stop global warming and the destruction of the natural environment, develop an efficient way of delivering health care, wean our country from dependence on foreign oil, advance our country’s interests abroad – all of these things require that Americans understand and act on their common interests. But extreme inequality of incomes makes this very difficult. One pattern that has emerged as a result of the explosion in incomes at the top relative to the bottom and middle is the increasing isolation of the rich from the rest of society. The rich hide themselves away in exurban communities of gates and McMansions where they spare themselves the indignity of rubbing shoulders with the ordinary people. They pull their children from public schools. They socialize in clubs, they go to churches, they take their entertainment in places that are inaccessible to those in the middle of the income distribution. The increasing isolation of the rich is evident not just in the explosion of McMansion communities, but in such things as luxury box seats at stadiums, the disparate treatment of airline passengers depending on their designated class (premium, premium gold, business premium elite, …), the proliferation of luxury resorts and time shares and indeed the transformation of whole communities like Veil, Colorado, into private reserves of the uber-rich. The desire of the rich to separate themselves from the rest of society – spiteful inegalitarianism – is not only distasteful but harmful to our democratic society. How is this segment of the population supposed to see the community’s common interest in public education when its members can send their children to private school; in an effective police force when they can hire private security guards to protect their property; in protection of the environment when they can reserve plots of land for their private playgrounds? One need look no further for evidence of the degree to which the upper classes have lost any understanding of the conditions of the majority of the American population than the students at Gettysburg College, most of whom come from privileged backgrounds and for whom the life of families trying to get by in minimum wage jobs, lack of health insurance, and discrimination are foreign and purely abstract concepts. It is with good reason that the Founding Fathers rejected aristocracy and that Americans have always prided themselves on having a classless society. Yet these are precisely the principles that are in jeopardy as a result of the widening distribution of income.

Finally, extreme inequality of incomes is not in the long-run interests of the rich themselves. The “winners” in our society achieved their position thanks largely to a particular economic policy regime – private enterprise, free trade, low taxes, and so on. Economists argue that these policies create more “winners” than “losers” and therefore are beneficial to society as a whole. Indeed at the aggregate level the U.S. economy has been phenomenally successful over the past 40 years, moreso than most other industrialized economies. But how can economists and the rich who benefit from this policy regime convince the bottom half of the income distribution to support these policies when the benefits largely elude that segment of the population? How long will it take for the bottom 50 percent to impose on society a different policy regime that protects their interests at the expense of those at the top – stronger unions, protectionist trade policies, confiscatory taxation, and the like? It will do no good at that point for economists to tsk-tsk the public for killing the goose that lays the golden eggs. The deal is that the “pro-growth” policy regime creates enough wealth so that the winners can compensate the losers, and everyone is better off. If society does not in fact compensate the losers then it is the proponents of the pro-growth policies, not the bottom 50 percent, that has reneged.