The Shibboleth of "Fixing" Income Inequality

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In a recent New York Times Op Ed entitled "Income Inequality: Too Big to Ignore" Professor Robert Frank castigates economists that are reluctant to condemn the gap between rich and poor. He blames our current woes on the distortion of community norms that drive the rich to overspend elusively seeking happiness, which encourages people of lesser means to bankrupt themselves trying to ape the rich. Q.E.D.: income inequality is bad and if we don't do something about it our roads and bridges will crumble.

Got that?

The real reason rational economists hesitate to make value judgments about income inequality is that unlike measures such as longevity, infant mortality, and rates of literacy, income inequality is not a primary indicator of a society's health and well being. Some pretty awful places have no income inequality.

The nature, causes, and consequences of unequal income production are what ought to interest economists, not to mention any young person making education and career choices. Note that I call it income production and not income distribution. Calling it the latter presupposes a fixed pie of income that descends from the heavens, the greedy rich grabbing the lion's share leaving crumbs for the poor. Arguments about the fairness of "income distribution" are not really arguments at all. They are tautologies that embed preconceived answers in the question, allowing no rebuttal.

A few simple examples show why some increases in income inequality are desirable, some are a matter of indifference, and some are a cause for outrage. The same is not true about infant mortality, longevity, and rates of literacy.

Imagine a hypothetical society with a bell shaped income curve with a median annual income of $25,000. Imagine that over time this society doubles its productivity and, consequently, everyone's income doubles while the shape of the overall distribution remains the same.

Income inequality has doubled. Has this society become worse off? Of course not. Is any member of that society worse off? Nope, the poor can buy more stuff. Will envy go up when the rich spend on luxuries? Sure.

As prosperity spreads will people start considering those luxuries to be necessities? They always have. Could a healthy bit of envy spur everyone to work harder, longer, or smarter? Only if someone doesn't hand out these newfound "necessities" for nothing.

Will the accumulation of unspent income by those at the top help finance new technologies and industries, making those at the bottom more productive? This is how Capitalism works. Has this approach for allocating capital lifted more people out of poverty than any other, or should it be condemned by economists and Op-ed columnists because it is fueled by income inequality?

Imagine a society in which a young person starts life with a low income which rises through his career then declines in retirement. A mixed distribution of such people would show significant income inequality even if every person experienced identical life trajectories. A prudent balance between saving, borrowing, and spending allows any individual to redistribute consumption across his own life as he chooses. Is it better to take away these choices and "fix" inequality by redistributing income between generations using a coercive Ponzi scheme? This is how Social Security works. How will that "fix" be sustained now that Congress has looted the Social Security trust fund?

Imagine a society in which some genius invents a cure for cancer and he and his stock option empowered employees become fabulously wealthy, making income inequality go up. Anyone arguing that this makes society worse off would have to admit to preferring widespread cancer over the occasional Ferrari. Would opinion leaders berate our inventor for being greedy? Would his company be investigated for anti-trust violations at the urging of competitors? Would our inventor have to earn his way back into the good graces of professors and Op-ed columnists by setting up a charitable foundation to care for the sick in Africa? Am I making this example up or have we seen this show before?

Imagine a society in which celebrities amass wealth by voluntarily separating fans from their money. Does this contribution to income inequality need to be fixed? Imagine said rich celebrities calling for higher taxes on entrepreneurs and small businesses while seeking government subsidies to film their movies. This is how Hollywood works.

Imagine an advanced technological society in which real incomes of the uneducated stagnate, incomes of the middle class grow modestly, and incomes at the top soar. How has this society become materially worse off? Does the existence of some rich guy's ski chalet in Vail reduce the housing stock in Detroit? If the poor get obese eating hamburgers is it the fault of the rich dining on filet mignon? Will envy go through the roof if the media fixates on the lifestyle of the rich and famous? This is how contemporary culture works.

Will demagogues fan the flames of envy to achieve political power, using this power to confiscate money from the rich to buy votes from the poor? Will they hobble successful companies with higher taxes and restrictive labor laws, demonizing the very businessmen that are supposed to create jobs? This is how Progressivism works. Will progressivism drive both capital and productive industries out of the country, making it more difficult for people to find work? Look around you.

Imagine a society in which politically connected individuals enrich themselves by giving money to politicians in return for earmarked dollars extracted from taxpayers. Imagine political entrepreneurs displacing market entrepreneurs by weaving fantastic tales of energy independence and a green tomorrow, sucking down billions in taxpayer loan guarantees for businesses that cannot possibly achieve economic sustainability. This is how crony Capitalism works.

Imagine a handful of executives earning hundreds of millions of dollars selling toxic mortgage bonds pyramided on low cost government-guaranteed capital made available by key Congressional committee chairmen who got special mortgage deals. Imagine a revolving door between reckless Wall Street derivative gamblers selling fraudulent unbacked insurance products and the regulatory agencies that bail them out using unlimited quantities of fiat currency printed up by unelected bureaucrats. This is how Washington works.

Are these the people Robert Frank wants to call on to "fix" the income inequality problem?

Imagine a workers' paradise in which income inequality is eliminated by government command. Wait, we don't have to imagine. Go visit Cuba.

Bill Frezza is a fellow at the Competitive Enterprise Institute, and a Boston-based venture capitalist. You can find all of his columns, TV, and radio interviews here.  If you would like to have his weekly columns delivered to you by e-mail, click here or follow him on Twitter @BillFrezza.

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