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U.S. Income Inequality: It's Not So Bad

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Letter Writer:

John Shelnutt, an economist in Little Rock, Ark.

Date Posted:

Oct. 28, 2008


Tom Garrett (the author of the article) has overturned countless studies and updates of income inequality assessments in one efficient stroke of careful analysis of the data and analytical flaws in prior approaches. He also highlights the role of official data sources in spreading the interpretive problems with misguided reporting routines.

Letter Writer:

James N. Morgan, emeritus professor of economics and research scientist, Institute for Social Research, University of Michigan; fellow of the American Statistical Association; member of the National Academy of Sciences

Date Posted:

Oct. 28, 2008


The article by Thomas Garrett, “U.S. Income Inequality: It’s Not So Bad,” first provides some evidence that a wider measure would show less inequality, then argues that inequality is useful and necessary for a vibrant economy. The first ignores many other ways in which inequality is actually greater than our measures, and the second is wrong, and in addition there are many other ways in which inequality causes trouble.

First, if you include the fact that the lowest income families are less likely to have health insurance, more likely to live in dangerous neighborhoods, work longer hours for their income and suffer greater insecurity, total inequality of well-being is still larger.

Second, so long as not more than half of any additional dollar of income is taxed, one can do much more redistribution of income without impairing incentives. Actually, income taxes reduce risk, taking less if your income falls and more if it rises. The marginal federal income tax on the last dollar earned has dropped from 91 percent to 35 percent, and back when it was somewhere in-between, we conducted a national sample focused on the affluent, asking how many hours a week they worked, how much of an extra dollar of earning would go to taxes, and whether that had any effect on their work effort. (Morgan et al. The Economic Behavior of the Affluent, Brookings, 1966). The overwhelming answer to the third question was “no.”

But there are other and serious bad effects of economic inequality: It leads to political corruption and to crimes of the poor, like prostitution and drug running. It violates a basic assumption behind the theoretical justification for free market capitalism, i.e., that market demand and prices are good guides for what to produce and how to produce it. Does anyone believe that our allocation of resources to infant health and to cosmetic surgery is justifiable?

Even worse, inequality leaves the masses without adequate income to provide full employment and the few affluent without real investment opportunities; so, the affluent and corporations bid up the prices of stocks and other existing assets. There is good historical evidence that trickle down never worked, but trickle it did. A book by Larry Bartels of Princeton titled Unequal Democracy shows how Republican regimes benefited only the upper income groups, while Democratic regimes, focusing on the poor, helped the affluent nearly as much.

Finally, a progressive tax structure provides some automatic stabilization, reducing taxes in bad times and increasing them during booms. We have eliminated most of the progressivity in our tax structure.

The present focus on financial markets ignores all this and, worse still, assumes that you can induce more economic activity by reducing interest rates. Most economists would agree that you can hold back excessive activity by raising rates, but that attempting to encourage investment by reducing interest rates is like pushing on a string.

Change in our tax structure is a slow process. What can be done in the meantime relies on another bit of basic economics known as the balanced budget multiplier. Expanding government expenditures and taxes at the same time leads to three times the growth in national output. We could vastly expand our expenditure on roads, bridges, waterways, etc., funded by an increase in the tax on gasoline. Recapturing the gains as the price falls from, say $3.50, would not only pay for massive improvement to our infrastructure, but would encourage more fuel saving by removing any expectations of cheaper fuel in the future.

Response from Author of Article, Tom Garrett:

Several points raised by Professor Morgan are addressed.

First, Professor Morgan confuses income inequality and poverty. The social ills that Professor Morgan describes, such as crime, lack of health insurance, drug abuse, etc., are a result of poverty and not income inequality. Those at the lowest end of the income distribution will still suffer negative consequences regardless of how rich others are. Consider the following example: Suppose an economy has 10 people each making $10,000. All 10 people are below the poverty level, and income inequality is zero. Now suppose one of these 10 people finds $1 million in a trash can. Income inequality now increases dramatically, but the well-being of the nine people still making $10,000 a year has not worsened. The point here is that the well-being of the nine people is a function of their poverty-level income and not the income of the now-wealthier individual.

The only reason to implement policy to reduce income inequality is that society would be better off if the poor had more money and the rich had less. But this suggests that the societal utility function for income exhibits negative marginal utility, i.e., society becomes better off the lower its income level. Any policy designed to reduce income inequality by taking from the rich and giving to the poor is not based on sound economic reasoning, but rather is based on emotional responses by "spiteful egalitarians," as noted by the economist Martin Feldstein. (Paper cited in original article.) On the contrary, reasonable arguments can be made for poverty-reducing policies.

Second, the article does not argue against a progressive tax system as Professor Morgan suggests. The point made in the article is that taxing the rich simply because they are rich, which is the de facto goal of any policy to reduce income inequality, is not sound policy given the disincentives to entrepreneurship and innovation higher taxation brings.

The author also disagrees with Professor Morgan’s claim that higher marginal tax rates do not decrease the incentive to work. Recent empirical work has demonstrated that higher marginal tax rates lead to greater growth for initially low levels of growth, but with an infrastructure in place, increasing marginal rates results in slower growth.

Professor Morgan argues that trickle-down policies do not work. Whether this is true or not, one thing is for sure—higher taxes, be they income taxes, capital gains taxes or business taxes—are to some degree passed along to consumers, some of whom are the lowest-income members of society. The point made in the article is that sound policy to reduce poverty must evaluate the costs and benefits of transferring income from the wealthier in society to its poorest members.

Letter Writer:

John M. Pimenta of Wheaton, Ill.

Date Posted:

Oct. 28, 2008


It should not surprise you that a garden variety non-economist citizen like me is reading learned papers like yours in these troubled times. I thank you for the clarity of your writing, which makes it possible for a person like me to understand your recent paper on "U.S. Income Inequality: It's Not So Bad," appearing in the October 2008 issue of The Regional Economist.

In my own uninformed way, I have questions about some of the statements and conclusions of your paper:

  • You state that "Wealthy people are not wealthy because they have more money; it is because they have greater productivity." In what way do wealthy people have "greater productivity"- is this capital productivity you are talking about or productivity of their labor?

    I am disappointed that you did not elaborate on this point in your paper, especially since you conclude with another statement that "Different incomes, thus, reflect different productivity levels" How so?
  • At another point, you state: "Sound economic policy to reduce poverty would lift those out of poverty (increase their productivity) while not reducing the well-being of wealthier individuals."
    Why does it enter your mind that lifting people out of poverty is a zero-sum proposition. Cannot poverty be reduced by giving the poor the same tools as the wealthy do—viz access to capital credit (in addition, of course, to the tools you cite, viz education and job training)?
  • Finally, your overall philosophy appears to be that "income inequality is the byproduct of a well functioning capitalist economy"—presumably even a democratic capitalist economy. If this is the case, why would the grass roots of any country, whether ours or in emerging economies, favor such an economic system, especially now in the face of the meltdown of the "capitalist economy" which needed to be bailed out by the taxpayers of the country?

Thank you for educating me on these points, and thank you again for your interesting insights on the flaws in the way income inequality statistics are compiled and reported.

Response by author of article, Tom Garrett:

I am glad you enjoyed the article. Below are my responses to your comments.

  1. Here I am relating income to marginal productivity, that is, the value of one's labor. Income is positively correlated with the value of labor. Think of a major league baseball player versus a janitor. The former is highly skilled and generates large revenues (through ticket sales, etc.). Not everyone can be a major league ball player. On the other hand, janitorial work is low-skilled labor that most people could perform.

    Perhaps it would have been more clear if I used "higher income" rather than "wealthy," although the difference is minor with regard to the point being made. Also, with a limited word count for the article, it would have been difficult to expand on this further without sacrificing other pertinent information.
  2. I do not claim that lifting people out of poverty is always a zero-sum gain, and I agree there are other ways to lift folks out of poverty other than transferring income from the rich to the poor. I discussed taxation in the article because when the discussion involves income inequality, there is most likely a discussion of transferring income.
  3. I would argue that any economic system should be evaluated on its long-run performance, rather than any short-run performance. Certainly, capitalism is not perfect, but it is that very system that has propelled this country to the greatest economic power on the planet. Even the poorest folks in the United States have a standard of living that is much higher than poor people in other countries. Furthermore, there are numerous factors that have played a role in the current crisis, many of which are not related to our specific economic system.

Thanks again for your interest.


Subsequent letter from Pimenta:

Date Posted:

Oct. 28, 2008


I hesitate to take up more of your time with further interaction but I am compelled to do so because of the importance of your paper to our current political discourse. In view of the editorial limitations imposed upon you by the print media, would it be possible for you to explain your thinking through an expanded paper on your web site?

You are an economist in a position to influence public policy through your platform at the St. Louis Federal Bank, and I, of course, am not an economist and yet I find that my vote as an uninformed private citizen is equal to yours in our democratic system.

The subject of your paper, "Income Inequality," is precisely why I have voted for Obama/Biden in early voting in my county. My hope and expectation is that the economists listed on his advisory team will find a way to mitigate income inequalities inherent in our democratic free market economic system, since as you affirm "sound economic policy to reduce poverty would lift those out of poverty (increase their productivity)" while not reducing the well-being of wealthier individuals, the Joe the Plumber episode notwithstanding

On the other hand, in your paper you assert that "It is important to understand that income inequality is a byproduct of a well-functioning capitalist economy. Individuals' earnings are directly related to their productivity." I hope you will understand why this is most disconcerting to one who has placed his faith and resources in a democratic free market economy which, for whatever reason, has been brought to its knees.

In your response, you cite as an example the relative marginal productivity of a baseball player vs. a janitor. What in your view is the "marginal productivity" of the high income of the senior executives of the failed investment banks which we low productivity citizens are now in process of bailing out?

At another level, what is the "marginal productivity" of a second-grade teacher who produced a Warren Buffett or a Bill Gates?

You question whether income inequality is worthy of public policy. How else would you correct the imbalances in the above cited examples of "marginal productivity"?

I look forward to your response since I am in contact with a number of fellow citizens who are equally troubled by this question in selecting the next president two weeks hence.

Thank you again for your kindness.

Garrett's second response:

At this time, I have no plans to elaborate further on the subject, although I will not rule it out in the future. I will make a few final points:

I reiterate that there is nothing inherently bad about income inequality. To better illustrate the point I was making in the paper, consider the following example: Suppose an economy has ten people each making $10,000. All ten people are below the poverty level, and income inequality is zero. Now suppose one of these 10 people finds $1 million in a trash can. Income inequality now increases dramatically, but the well-being of the nine people still making $10,000 a year has not worsened. The point here is that the well-being of the nine people is a function of their poverty-level income and not the income of the now-wealthier individual. A good public policy would aim to help the nine people still in poverty without vilifying the richer individual.

In terms of the marginal productivity of teachers and teacher pay, I think it is important to realize that teacher salaries are constrained by political factors, such as local taxes, balanced budgets, etc. A free market for teachers would allow the super-star teachers to earn much more than they are earning now. Great teachers would be rewarded, while bad teachers would not be.