Redistribution schemes can’t reduce income inequality. What can? Education, stable families, and work. By Jeffrey M. Jones and Daniel Heil.
The president and Congress are seeking a solution to the worst economic recession since the Great Depression. Lurking beneath President Obama’s economic agenda are campaign promises and political appeals that call for societal change on a grand scale. For example, on the eve of Martin Luther King Jr. Day, the incoming president stood at the civil rights leader’s historic pulpit and spoke of the need for unity. Americans must unite, Obama demanded, to end the country’s moral deficit. "CEOs are making more in ten minutes than some workers make in ten months," he said.
In an interview with the New York Times a few weeks later, Obama criticized the "structural imbalance in our economy . . . where increasingly the benefits of economic growth [are] accruing to a smaller band of people." To counter this "trickle-down economic growth," Obama promised to simultaneously raise taxes on the wealthy and lower taxes on the working or middle class "to create a more lasting and equitable prosperity." Obama’s statements confirm the sentiments of countless Americans. If only the rich earned less, they argue, the poor would have more.
There is little reason, however, to believe that reducing income inequality would improve the welfare of the poor. We only validate envy by concentrating on relative income differences and breed resentment when we blame the enviable. Instead, our focus should be on advocating measures that will advance the absolute well-being of the working poor.
THE CURIOUS CASE OF INCOME INEQUALITY
Obama is not alone in his crusade against income inequality. The Institute for Policy Studies began its Working Group on Extreme Inequality in 2007 to lobby against the accumulation of wealth by the "ultra rich." The Nation devoted an entire issue to it last June, citing the academic research of UCBerkeley economist Emmanuel Saez. Relying chiefly on income tax returns, Saez found that between 1980 and 2004, the share of income earned by the top 1 percent of earners rose from 8 percent to 16 percent. In a February 2007 speech, Federal Reserve Chairman Ben Bernanke argued that "rising inequality is not a recent development but has been evident for at least three decades."
Explanations for the disparity vary. Greater immigration rates, fewer private sector unions, and more globalization are all offered as rationales. The most likely cause, however, is also the engine of America’s unprecedented prosperity: technology. Specifically, vast technological improvements have greatly increased the productivity of skilled workers, drastically increasing their wages. Those lacking the requisite skills are left behind.
Regardless of the reason for income inequality, those with populist leanings have reached a consensus that it endangers America’s economic and political well-being. The Working Group on Extreme Inequality claims that concentrated wealth gives a disproportionate share of political power to the affluent, weakening democracy and ensuring greater corruption in government. Voter turnout is low because the poor believe they will be disenfranchised. City dwellers set themselves apart by income level, discouraging community involvement.
Recently, social scientists have tried to measure the harm done to an individual’s well-being by the knowledge that someone else is relatively better off. This "happiness research" finds that relative income disparities dilute one’s happiness more than absolute increases in wealth advance it (at least above certain income levels). Consequently, for society to maximize happiness, it is argued, income inequality must be significantly reduced.
New research, however, is beginning to challenge the assumption of rising income inequality. Alan Reynolds of the Cato Institute and others find that previous studies have failed to account for changes in the tax code and, consequently, overstated the increases in the individual earnings of wealthy taxpayers. Taking another tack, University of Chicago economists Christian Broda and John Romalis find that income inequality has remained constant when one accounts for relative changes in the prices of goods purchased by the poor and those purchased by the wealthy. In other words, thanks to globalization and stores such as Wal-Mart, goods purchased by the poor have become relatively less expensive than goods purchased by the rich.
The most likely rationale for growing economic disparity is also the engine of America’s unprecedented prosperity: technology.
Moreover, those who argue that the rich are not paying their fair share should note that, in the latest Internal Revenue Service data, as reported by the Joint Economic Committee of Congress, "the share of total federal income taxes paid by the top 1 percent of tax filers increased to 39.89 percent in 2006 . . . the highest on record." The Congressional Budget Office recently examined the current effective tax rates of all Americans (total taxes divided by total income) and found that the lowest-earning fifth of Americans pay 4.3 percent in taxes; those in the top 0.01 percentile pay 31.5 percent.
THE ENVY TRAP
Without question, destitution exists in the United States. Rising unemployment and housing foreclosures have put more families at risk. But blaming income inequality and punishing the rich would be a mistake.
Wealth is not the only measure of well-being. Family and friends, community involvement, leisure activities, and charitable work—all of which enhance the quality of life—are neglected when society focuses too closely on relative income differences and bolsters an empty materialism. Although there are certainly many reasons why poverty can result in unhappiness—hunger, disease, and homelessness, for example—resenting what others have leads to envy and, especially in regards to public policy, a dead end.
In The Metaphysics of Morals, Immanuel Kant defined envy as
a propensity to view the well-being of others with distress, even though it does not detract from one’s own. [It is] a reluctance to see our own wellbeing overshadowed by another’s because the standard we use to see how well off we are is not the intrinsic worth of our own well-being but how it compares with that of others. [Envy] aims, at least in terms of one’s wishes, at destroying others’ good fortune.
Our fascination with rising income inequality as a public policy dilemma provides a political justification for encouraging envy. Reducing income inequality through redistributive policies aims to punish the "haves" as much as it claims to help the "have-nots." Focusing on relative disparities suggests that people have the right to resent others’ good fortune, hard work, or income. As philosophy professor David E. Cooper articulates in his essay "Equality and Envy," "The idea that some should have less because others have less is an extraordinary idea—yet it is entailed by the egalitarian idea."
Thanks to globalization and stores like Wal-Mart, goods bought by the poor have become relatively less expensive when compared to goods bought by the rich.
Previous generations thought of envious people as morally deficient; the modern world thinks the enviable are morally deficient. Will greater wealth redistribution end the perceived moral deficit facing America? Will legitimizing envy and vilifying the enviable help the poor? Perhaps the better question is, are there public policies that lead to tangible improvements in the well-being of impoverished Americans, without harboring the vice of envy?
A WAY UP: INCOME MOBILITY
In these difficult times, it is tempting to doubt the ability of the free market to restore prosperity. Commenting on Obama’s stimulus plan, Bill Galston, a senior fellow at the Brookings Institution and a former aide to President Clinton, said, "The three-decade-long period where the default assumption was that government is the problem, not the solution, has clearly ended." Advocates of wealth redistribution are skeptical of the aims of capitalism and convinced that government should have a larger and more active role in providing for the common good.
We would do well to recall the late Milton Friedman’s famous saying:
A society that puts equality—in the sense of equality of outcome—ahead of freedom will end up with neither equality nor freedom. The use of force to achieve equality will destroy freedom. On the other hand, a society that puts freedom first will, as a happy by-product, end up with both greater freedom and greater equality.
Less familiar, but no less incisive, is what Friedman said next: "Freedom means diversity but also mobility. It preserves the opportunity for today’s less well off to become tomorrow’s rich, and in the process, enables almost everyone, from top to bottom, to enjoy a richer and fuller life." Capitalism, in the form of the U.S. economy, is not a zero-sum game. If the rich have more, the poor do not have less. Income inequality certainly exists at any time, but differences in long-run income status are "a sign of dynamic change, social mobility, equality of opportunity."
Repeatedly being told that one is not keeping up with the Joneses makes one more inclined to embrace materialism to establish an illusion of wealth.
How much income mobility exists in America? Research consistently affirms that there is substantial upward income mobility in the United States, with the lowest income earners typically showing the strongest results. A Treasury Department study of the 1996–2005 period used IRS income tax data to discern considerable mobility: more than 55 percent of taxpayers moved to a different income quintile. More than half the people in the lowest fifth of earners moved to a higher quintile over this period (29 percent to the second, 14 percent to the third, 10 percent to the fourth, and 5 percent to the highest).
Moreover, there is a great deal of movement in and out of the top income groups. The Treasury data show that 57 percent "of households in the top 1 percent in 2005 were not there nine years earlier." The rich sometimes get richer, but they get poorer as well. The study also reveals that income mobility has increased, not decreased, during the past twenty years. For example, 47.3 percent of those in the lowest income quintile in 1987 saw their incomes increase by at least 100 percent by 1996. That number jumped to 53.5 percent from 1996 to 2005.
In focusing attention on relative disparities, we encourage people to resent others’ good fortune, hard work, or income.
If income mobility is an economic prescription for lifting families out of poverty and into the middle class and beyond, what contributes most to such mobility? What steps can individuals take, supported by sound public policy, to move up the income ladder?
The research is clear: education is unquestionably the most important factor and is in fact growing in importance. Economist Kevin Murphy notes that increases in wages during the past forty years are closely affiliated to education. Higher education levels are rewarded with higher wages because employers increasingly require highly skilled workers. In response to the demand, more people choose to attend college; many of them, however, are unprepared and fail to graduate. Millions of other students never graduate from high school. The connection between education and income mobility should challenge individuals to stay in school and politicians to help them succeed and stay there—working for teacher quality, school choice, early childhood education, and so on.
Marriage and family also significantly enhance income mobility. Citing Michael W. Cox’s book Myths of Rich and Poor, economist Walter Williams notes that "only 7 percent of top income earners live in a ‘nonfamily’ household, compared to 37 percent of the bottom income category." Married couples tend to have larger, sustained incomes, in part because of the prevalence of multiple earners in those families. Family poverty is largely a single-parent phenomenon—Current Population Survey figures for 2007 show that 24.5 percent of all single-parent families lived below the poverty line, compared to only 4.9 percent of married-couple families.
Getting married and staying married would help put low-income Americans on the path to upward mobility. Government could take an active, positive role in promoting marriage by removing tax and welfare rules that penalize it. Political scientist James Q. Wilson has called for the "Department of Health and Human Services [to] launch an ambitious program . . . to identify and test marriage promoting programs so that those that work can be widely advertised."
The research is clear—education is unquestionably the most important factor for moving up the income ladder, and is in fact becoming even more important.
Also, studies indicate, people who are more willing to take risks will experience increases in income. Friedman articulated this concept when he argued in his classic paper Choice, Chance, and the Personal Distribution of Income that inequality in the distribution of income will be greater in societies that encourage risk taking than in those that are risk-averse. The reward for risk is a greater opportunity for individual mobility. On the other hand, if someone believes that there is no hope in increasing his income, he will be less willing to take risks because the expected gain is small. (Of course, the mortgage crisis is a valuable lesson about taking on too much risk or the wrong kind.)
Research by Kathryn L. Shaw suggests that education encourages greater risk taking because individuals with education can better weigh the expected costs and benefits of an action. A practical example of risk enhancing income is willingness to move from a place of low opportunity (i.e., high unemployment) to one where jobs are more plentiful. Another helpful suggestion, in light of the troubled economy, comes from Alberto Alesina of Harvard and Luigi Zingales of the University of Chicago, who state, "There is no better way to encourage [people to take more risk] than a temporary elimination of the capital-gains tax."
Finally, income mobility is due to "persistence in work." Income typically comes as wages paid for work performed. In 1995, the Federal Reserve Bank of Dallas reported that 80 percent of individuals in the highest income bracket worked full time, whereas 84 percent of those in the lowest bracket worked part time. Economist and Hoover senior fellow Thomas Sowell notes that "most households in the bottom 20 percent by income do not have any full-time, year-round worker, and 56 percent of these households do not have anyone working even part time." (The figures are from the year 2000.)
Persistence also applies to the long run. Incomes rise as workers age. According to the Federal Reserve Bank of Dallas: "Households headed by someone under age 25 average $15,197 a year in income. Average income more than doubles to $33,124 for 25- to 34-year-olds. For those 35 to 44, the figure jumps to $43,923. It takes time for learning, hard work, and saving to bear fruit."
Full-time employment over the course of one’s productive life usually results in significant income mobility. Although the federal government is the largest U.S. employer, with more than 2,700,000 employees (surpassing Wal-Mart by approximately 600,000), it comprises just 2 percent of the nation’s workforce. The vast majority of jobs are created and paid for by corporate America. Thus, public policy to encourage income mobility would make it easier for businesses to operate, innovate, produce, and grow. The jobs will follow.
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Sensible, time-tested steps that produce upward income mobility point to one conclusion: there are no shortcuts. The goals are to work, invest, partner, and learn, and to focus on personal responsibility. The economics of income mobility replace envy with effort.
Jeffrey M. Jones is an assistant director and a research fellow at the Hoover Institution.
Daniel L. Heil is a research fellow at the Hoover Institution. His focus is on the history and future of federal anti-poverty programs. Heil’s primary interest is replacing failed policies with state and federal initiatives that alleviate poverty by encouraging work force participation and human capital development. His research examines the effect anti-poverty measures have on recipients and the extent the public supports various means-tested programs. Heil has written on the perils of telecommunication regulations in Is Regulation a Roadblock on the Information Highway from the Handbook of Research on Telecommunications Planning and Management for Business; and the economic effects of e-business in The Macroeconomic Impacts of E-Business on the Economy.
Heil graduated from California State University, Northridge, with a BA in economics. He received a master’s of public policy degree specializing in economics and American politics from Pepperdine University.
Special to the Hoover Digest.
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