Thinking Carefully about Monetary and Non-Monetary Inequality

There is a large disconnect between the specific problems and remedies that are being discussed here and the macro measures of income inequality that generated this debate. Measured inequality is often unaffected by these policies.

Consider Elizabeth Anderson’s desire to increase welfare and government transfers to the poor. No matter how generous these are made, they cannot have an effect on income equality since, by definition, these welfare payments are excluded from income measures which are usually derived from tax data. So if welfare payments are good, it is not because they address the measured income inequality.

It is well known that attempts to measure the incomes of the lower tail are severely biased by ignoring transfers from the state and from friends and relatives as well as the problem of unreported earnings from the underground economy. The latter issue includes anything from unreported tips and cash payments to illegal businesses and organized crime. For that reason, economists like to look at measures of consumption, which as Will has already noted show a much lesser degree of inequality than measures of income. This is consistent with the intuition that the lower end incomes are simply not measured properly or go unreported.

At the other end of the scale, it is also well known that reported income measures do not capture well the wealth of the very rich. That is why Lane Kenworthy’s suggestion of raising the top marginal income tax rate a few points is so odd. Research on worldwide trends suggests that the wealthiest members of society have been shifting income to equity because it makes it easier to shield their earnings from the taxman. And there are well known limits on how much and how easily you can tax equity and corporations without strong negative consequences. Moreover, the wealthiest are more able and willing to use legal and accounting techniques to hide their assets from the state. Hence any tax increase will almost certainly hit the upper middle class and high wage earning members of the population while leaving the true plutocrats relatively unscathed. It is easier to tax successful doctors and managers than the Warren Buffetts and Bill Gateses of this world. Indeed, in much of Europe there are lower corporate taxes than there are in the United States, and capital gains taxation is quite varied the world over.

At the same time, the fact that measured inequality ignores differences in the cost of living in different parts of the country means that a tax on high nominal income will punish dual wage earners in expensive areas relative to those who might have higher real living standards but lower costs. Do you really believe that big-city couples with high incomes should pay higher taxes than rural or suburban families with similar consumption but lower reported earnings? And of course, any attempt to adjust taxes to take this into account would result in nightmares of bureaucratic compliance and rent-seeking, not to mention induce distortions in production and the labor market. Moreover, it is not clear that the changes Lane Kenworthy proposes would do much to affect the overall income inequality measures. Would this justify continuing to increase taxation till some particular index flipped substantially?

For these and many, many other reasons (e.g. differences in age profiles will affect measured inequality, as will treatment of singles vs. households) most countries focus on simply enhancing welfare to the poor or balancing different public policy concerns, and they do not directly address the measured inequality gaps. Explicitly redistributive taxes to curtail the incomes of the rich (as opposed to the entirely different issue of how much of a safety net to provide) often have quite negative consequences. To take as a very crude example: In the 1960s, most countries in the West had high marginal tax rates, often in the 90-95% range. (The Beatles’ song “Taxman” had a line, “It’s nineteen for you and one for me,” reflecting their own struggles with taxation.) These have all been abandoned because they had huge negative consequences, such as forcing emigration or damaging productivity, and were often evaded by the wealthiest as capital markets became more fluid. Yet even with lower modern tax rates, many notable celebrities in France, for example, have changed residence to Switzerland to preserve income.

Moreover, I asked about non-material inequalities because I still believe that the focus on monetary resources as the only assets deserving of redistribution is misguided. Many of the greatest inequalities are not monetary and often the financial differences we see are only the residual fallout of these other differences.

Consider that the dominance of bosses and corporations is not just about wealth but power and social control. And the latter, especially when supported or created by legal or social inequities, are often substitutes for income. In much of the world, interlocking directorates and cozy corporate arrangements favoring the well-connected and politically influential are much stronger than in the United States and are often more important than cash payments. These don’t show up in measured inequality. Sometimes this could be as simple as generous allowances for discretionary spending that go untaxed, or special perks like memberships to exclusive golf clubs where the top deals are made (I believe these memberships can run to millions of dollars in value in some countries). Other times it is in anti-competitive measures that limit takeovers or shareholder democracy. In Northern Europe, cartels and price-fixing were either legal or much less severely constrained than in the United States for most of the last century.

I don’t think any income comparison of the United States to many other nations, nor to historical cases like the communist bloc or aristocratic Europe, even begins to capture the ways in which other nations had or have social arrangements that sustain inequality outside the cash nexus. Even in the United States today, much of the worst lobbying comes from different groups seeking a variety of special tax exemptions and industry favors. Increasing the complexity and scope of taxation will only intensify these efforts.

This is why I focused my original remarks on positional goods and inequalities due to individual or social endowment, in the hope of getting us all to Think Outside the Box. For reasons I still don’t understand, many people have an aversion to inequalities that are monetized but are otherwise oblivious to more persistent differences.

Even in the U.S., much of the income inequality of the last 30 years has been driven by the greater returns to education in the workplace. The meritocracy that has been promoted since World War II, however imperfectly, was partly a response to the problem that bright people from certain backgrounds were disadvantaged unfairly. To take only one prominent example, Jews and other minorities were often excluded or disadvantaged in admission to university, especially the Ivies (cf. Jerome Karabel’s The Chosen). Opening up university access and emphasizing academic merit has brought more talent to the fore and contributed to the diversity and success of American science and industry and higher education itself, but it has also led to a growing wedge in the compensation gap between the skilled and unskilled.

This is not just driven by inequalities in talent, training, personality, and intelligence but is exacerbated by differential trends in the family. Assortative mating has meant that highly educated couples in stable relationships produce offspring more likely to do well in school and the workforce than the poor, who are more and more composed of single parents with low human capital. Thus a child of bright, educated parents is often blessed with advantages over the child of a broken home in a bad neighborhood that cannot easily be fixed. It is readily observed that poor immigrant children from intact families do better even in the same schools and the same neighborhoods than their peers who are raised without fathers. Once more, a single-minded focus on financial inequality will miss this deeper and more intractable inequality.

Thus, most of the concerns about injustice or inequality I see in Kenworthy and Anderson do not directly correspond to the measured inequality stats. Do not be surprised if standard attempts to change the distribution are ineffective or do not assuage people’s concerns about their well-being, while nonetheless having negative unintended consequences. Let the focus be on unequal access, or minimal standards of living, or health care, or employment opportunity, not on coefficients of distribution.

Also from this issue

Lead Essay

  • In his lead essay, Will Wilkinson observes what he believes is a poor chain of reasoning: Income inequality is rising; it is also a measure of injustice. To fix this injustice, we should redistribute incomes. Wilkinson attacks this reasoning on several fronts: Income inequality is less important than consumption inequality, and consumption inequality is probably lessening. But if income inequality is a problem, it is so only as a symptom of a different problem: substandard schools, perhaps, or our high incarceration rate, or CEOs who conspire to overpay one another. Rather than redistributing income, we should identify the underlying problem and fix it directly. This may well lessen income inequality, and it will also fix an undoubtedly serious problem somewhere else in our society.

Response Essays

  • Lane Kenworthy argues that income inequality is indeed important, and that we should not be misled by the relatively reassuring data on consumption. Unconsumed income also adds to the quality of life enjoyed by the rich, even if that increase is still hard to measure. A more egalitarian society need not entail a radical social leveling, but it should entail better public services for the poor and the middle class.

  • John Nye adds several considerations to the mix: First, positional goods may make us feel more unequal — there are only so many “top ten” schools for our kids, only so many “best” views or neighborhoods. Yet, with rising incomes, more of us feel that we should be able to afford them, even as they slip further from our grasp. As we become more equal, we feel less equal. Second, one other effect of relative equality has been to erode the security formerly enjoyed at the very top of the economic pyramid. This security itself was a form of compensation, and executive salaries may be rising in recent years in part because executive security has fallen. And third, much of human inequality is not directly measurable in money at all. Differences in appearance, intelligence, ability, and the like are all real and may translate into economic inequality as well. Consideration of these elements is curiously absent from many discussions on inequality.

  • Elizabeth Anderson agrees with Wilkinson that the root causes of inequality are more troubling than inequality taken alone. But economic inequality is still a problem for two reasons: First, economic inequality of the sort we have today is not making the poor better off in absolute terms, but rather it is making them worse off. And second, economic inequality translates directly into inequality of political power, which in turn reinforces economic inequality. This is an unacceptable state of affairs.