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Does income inequality need fixing?

Ruminations February 16, 2014

Income inequality
Income inequality, said President Barack Obama last December, “is the defining challenge of our time. It drives everything I do in this office."

Although Obama didn’t use the term specifically, he implied that the Gini coefficient shows a growing disparity of earnings. Well, what is the Gini coefficient anyway?

Gini coefficient. Corrado Gini (1884-1965) was an Italian statistician of some repute. The facts that he had been president of the Italian Genetics and Eugenics Society or that he authored The Scientific Basis of Fascism should not detract from his famous coefficient. The Gini coefficient shows the disparity of frequency distributions; a coefficient of zero shows that everyone shares equally while a coefficient of one shows a concentration of distribution. When applied to income, as it frequently is today, a zero coefficient shows that everyone has the same income while a coefficient of one shows that one person has it all.

In one sense, it can be a meaningful statistic in that it can show a long term trend. As comparisons go, though, it can also be misleading. For example, The United States has a Gini Coefficient of 0.48 and Afghanistan has a coefficient of 0.28. That proves that Afghanistan has a more equal economy. Still, would you rather live in Afghanistan? Another example of Gini’s misuse would be comparing the Netherlands with Bangladesh – both have a Gini of .31 but Bangladesh’s per capita income was (in 21010) $1,693 while in the Netherlands it was $42,183. In spite of the similarities in Gini, the Netherlands and Bangladesh are not the same thing.

Inequality in the United States. In the United States the Gini has increased since 1967 (when it was first recorded) except for a brief decline from 2007 to 2010. This is closer to comparing apples to apples but remember that the Gini does vary by race, ethnic group, urban and rural area, etc. But let’s take the broader macro picture. The income gap has been increasing. Is that good or bad and, on what basis do you make such an evaluation?

Suppose, for example, that the income for the bottom half of the U.S. increases $10,000 per year. That’s good, isn’t it? But suppose that, at the same time, the income of the top half increases by $100,000. Is that good? The Gini will increase and the net income of the nation will increase as will each individual’s. Should that be the defining challenge of this presidency? Maybe.

There is little doubt that increasing the nation’s income is a good thing. And there is little doubt that as the nation gets richer, people expect more goods and services and that’s natural. If we choose to, in Obama’s words, “spread the wealth around,” how do we do it?

Creating more wealth. While some see wealth as finitely bound, most economists see wealth, long-term, as infinite. The U.S. Federal Reserve has chosen this path, through the creation of money, assuming that the Fed’s quantitative easing policy will make the U.S. so much stronger in the future that it will be able to pull back from the QE program with little impact.

Has it worked? Creating $3 trillion dollars has to have some effect on the economy though even the Fed will admit that it is disappointed with the results. But it has made some people richer. Who? The wealthy.

While Obama mentions that the Dow Jones Industrial Averages are at all-time highs, he doesn’t mention that one of the predominant causes of this record has been the Federal Reserve, whose policies have been complementary to Obama’s own fiscal policies – though decidedly not “spreading the wealth around.” To corroborate this evaluation, in 2012, the Bank of England issued a report stating that quantitative easing had benefited mainly the wealthy.

Unions. Obama thinks that stronger unions will help spread the wealth around. Will it?

In this age of political polarization, unions are either a strength of the nation or a dissipated self-interest group. Maybe a little of both.

There is no doubt that 1950s and 1960s industrial unions were the providers of labor and increased the earnings of their members. But the world has changed since then. Can we ever recapture that social-economic arrangement?

In the 1970s, the United Auto Workers were so strong that they contributed to the downfall of the American auto industry (but let’s not forget the auto industry management’s contribution to the general miasma). And today, we see the need for improvement in the nation’s education system and see the teachers’ unions as more protective of their members (as is their job) than of the students.

Unions that are too strong cause manufacturers, in the interest of survival, to export jobs – which is one reason why unions are opposed to granting Obama fast-track trade authority.

Taxes. What is the purpose of taxes? Is it to raise revenue or is it to spread the wealth around?

Normally, one would think that the purpose of taxation would be to raise revenue for the government and not, as Obama told Joe the plumber in 2008, to spread the wealth around. Granted, now it is not as easy as having one simple policy; we also want an equitable tax system. But is it equitable to tax some in or near poverty at the same rate that one would tax a high income earner? On the other hand, is it equitable to tax someone more just because that person earns more?

But we already do redistribute the wealth. Scott Hodge, president of the Tax Foundation, writing in the Wall Street Journal, cited 2013 reports by the Congressional Budget Office (CBO) and the Tax Foundation that found:
• Those in the bottom fifth, or quintile, of the income scale received $9.62 in federal spending for every $1 they paid in federal taxes of all kinds.
• Households in the top fifth received 17 cents in federal spending for every $1 they paid in all federal taxes.
• The middle quintile—the middle class—also got more back from government than they paid in taxes. These households received $1.19 in government spending for every $1 they paid in federal taxes.
• CBO's data indicate that federal tax-and-spending redistributed $1.2 trillion from the top 40% of households to their fellow Americans. Half of this amount benefited the bottom 60% of non-elderly households, while the rest benefited seniors.

Hmm. It seems that even if our goal was not raising revenue but spreading the wealth around it would be difficult. Hodge goes on to say that to close the gap between the top earners and the bottom would require the redistribution of $4 trillion. Could the economy take redistribution like that and still function?

Fallacies. One of the fallacies that some proponents of income equality cite is that the rich don’t deserve their inordinate income. That’s probably true. Does Alex Rodriguez “deserve” the salary that the Yankees pay him? Does the new CEO of General Motors, Mary Barra, “deserve” an annual salary of $4.4 million? Some might question whether Barack Obama “deserves” his salary. Suffice it to say that people are not paid salaries based on what they deserve; they are paid according to market conditions.

Another fallacy has to do with the zero sum game. Samuel Gregg, director of the Acton Institute, explains that, “The zero sum game is one of the great economic fallacies. It assumes that if one person gets rich, it must mean that someone else gets poorer. That’s reliant upon a static view of wealth. It’s like a pie; the idea that there’s just one pie, and the pie can’t grow. In market economies and dynamic, open economies what you’ll find is that the pie grows. This is very important because what that means is that everyone can start to get out of poverty.”

What to do? The first thing to do is to define our problem. Is it really income distribution? Is it taxation? Is it growing the economy? Is it the unions? If we conflate disparate issues we’re likely to come up with solutions that are neither satisfying nor effective.

Quote without comment
Bjorn Lomborg, a Danish writer, professor at Copenhagen Business School, director of the Copenhagen Consensus, former director of the Environmental Assessment Institute and author of The Skeptical Environmentalist, writing “A Report Card for Humanity: 1900-2050,” in The Atlantic, January, 2014: “Climate change is real and man-made, but one of the more startling findings is that it is expected to have a net positive benefit through mid-century… But why would climate change be beneficial? Increased levels of carbon dioxide work as fertilizer, boosting agriculture. This makes up the biggest positive impact at 0.8 percent of global GDP. Moderate warming also avoids more deaths from cold than it incurs additional deaths from heat. Finally, it reduces the demand for heating more than it increases the costs of cooling, totaling about 0.4 percent of GDP.”

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