Blog Post - Views on the Economy and the World

How to Address Inequality

| Apr. 24, 2014

Inequality has received a lot of attention lately, particularly in two arenas where it had not previously received as much: American public debate and the International Monetary Fund.  A major driver is the observation in the United States that income inequality has now returned to the extreme levels of the Gilded Age.  (The share of income held by the top 1% rose from 8% in 1980 to 19% in 2012, a level last seen in 1928, and probably the highest among advanced countries.  The share held by the top 0.1% rose from 2% to almost 9% currently, a level least seen in 1916. And mobility remains as low as ever.)  Inequality remains high in Latin America and has increased in many other parts of the world as well.

The current discussion goes beyond the starting point that we should be concerned about the distribution of the pie, not just about the total size.  It tends to focus on one of several extra “wrinkles” — adverse effects of inequality beyond the obvious one of the welfare of those with lower income.  One such wrinkle is the hypothesis that inequality is bad for overall economic growth (for example, in times of inadequate demand, because the rich save more than others).  Another is that inequality leads to volatility and instability (for example, that it may have been responsible for the sub-prime mortgage crisis of 2007 and hence the global financial crisis of 2008).

A third is the proposition that inequality translates into envy and unhappiness:  someone who would have been happy at a given income is unhappy if he discovers that others are getting more.  One persuasive version of this latter claim holds that top executives demand and receive outlandish compensation, not because they value so much the money itself, but because they compete with each other for status.

A fourth concern appears to trump even the first three.   It is the fear that, because there is so much money in politics, the rich succeed in getting governments to adopt policies that favor them as a class. The system often goes under the name of oligarchy.  It generates extra hand-wringing because of the notion that it is self-perpetuating.  The first three concerns have the consolation that they might at some stage be self-correcting, at least in a democracy.  After all, the upper 1 per cent doesn’t have many votes.  Under oligarchy, however, the concentration of economic and political power is self-reinforcing.  Recent decisions by the US Supreme Court regarding campaign contributions suggest that the role of money in the electoral process will only get worse.   Hence the outpouring of opinion columns and editorials sounding the alarm on the political-economy ramifications of inequality.

Each of these four concerns carries a big element of truth.   To do any one of them justice would require diving into the details.

Two examples.  On the relationship between inequality and growth: The one-time land redistribution that took place in northeast Asian countries after World War II was probably good for growth; but a system where the hard-working, thrifty, and entrepreneurial fear that they will not be allowed to keep much of the fruits of their efforts is bad for growth.  On volatility:  Programs to “help” the poor by facilitating housing loans that they cannot afford are bad for them and for financial stability, not good.

But what is wrong with working from the premise that poverty in particular and inequality in general are undesirable for their own sakes, other things equal?  I question the rationale for writing opinion columns that focus overwhelmingly on the political economy dangers of the wealth of the upper 1 per cent.  Yes those dangers are important.   But how useful is it to pursue the argument?

Even in the United States, most voters believe that inequality matters in addition to total national income. This is true even recognizing that the poor are less heavily represented among those who vote.  Even among the upper 1 per cent, approximately two-thirds believe that US differences in income are too large and support progressive taxation.  Most Americans believe in helping the less fortunate, provided it can be done without government intervening so intrusively or distorting incentives so much as to seriously damage economic efficiency.  The problem is that they often vote for politicians who enact laws inconsistent with those goals.  For example, someone hoodwinked the median  voter 10 years ago - most of whom themselves leave negligible estates - into believing that to protect small family-owned farms it was necessary to eliminate taxes on $ 5 million estates.

In other words, the problem isn’t that the median voter is unwilling to trade off any growth in return for more equality.  The problem is that the political process produces outcomes that deliver both less growth and less equality than we could get under the optimal tradeoff.

For the US, the most sensible measures include expansion of the Earned Income Tax Credit, elimination of payroll taxes for low-income workers, cutting deductions for high-income taxpayers and restoring higher inheritance taxes.  These are policies that reduce inequality efficiently, at relatively low cost to aggregate income.   Some further policies are “win-win” in that they may even promote overall economic growth while reducing inequality - such as universal pre-school education and universal health care — especially if these programs are financed out of efficiency-enhancing measures such as eliminating fossil fuel subsidies (and, preferably, taxing fossil fuels instead).   I’d also eliminate the carried interest loophole in the corporate tax code and deductions for stock options (while lowering the statutory tax rate).   Most of these proposals are supported by most independent economists, but it is hard to get the message across.

Meanwhile, there exist many government programs that are sold on the basis of improving income distribution but in fact impair economic efficiency severely with relatively little benefit for the poor or, on some cases, none at all.  The original rationale for wasteful agricultural supports was largely to help small farmers who were less well-off; but it has been a long time since they were positive for the income distribution.  Mortgage subsidies contributed to the sub-prime mortgage crisis, but the benefits go overwhelmingly to higher–income families.  Many Americans are persuaded to support such policies, not because it is in their interest, but because they don’t understand the economics.

Other countries also have similar programs that are sold as pro-equality but are inefficient or even harmful for that goal. In developing countries, measures that tax, subsidize or price-regulate food and energy tend to be highly inefficient tools for improving the income distribution, and frequently even have the opposite effect.  Of the $400-plus billion that countries spend on fossil fuel subsidies each year, for example, far less than 20% of the benefits go to the poorest 20 % of the population.  In general, a disproportionately small share of social spending goes to the poorest 40 % of the population.  Conditional Cash Transfers, on the other hand, have proven highly effective; they reach the poor and promote education and health.

How to nudge the political process toward delivering better policies?   Some believe that the appropriate stragegy is to sound the alarm about inequality and oligarchy.

The argument against oligarchy is not a perfect fit with the reality in the United States.  In the first place, most of the income of the upper 0.1% is still “earned” income, not inherited wealth (though Thomas Piketty’s best-seller argues that this is about to change).  In the second place, lots of single-issue groups are able to distort the political process severely, not just the rich.  In the third place, the opposition among the rich to measures helping the less unfortunate is far from unanimous.  Think of all the Bill Gates and George Soroses.  On the other side, think of all the unskilled workers who vote against their self-interest.

The anti-oligarchy logic for writing a column on inequality is that the rich have too much money, which they use to get the politicians elected and the bills passed that will favor them, the rich.  But how is that money weapon used?  Not often by outright bribery, at least not in the United States.  Politicians need money so badly for only two reasons: to get elected and to stay elected.  They buy advertising to persuade people to vote for them.  Hypothetically, if we could persuade people to stop watching the advertisements, that would solve the problem.

More constructively, if we could persuade the poor to vote, that might solve the problem.   But op-eds are probably not an effective means of achieving this, because those who are not civically engaged enough to vote are probably not civically engaged enough to read op-eds.  The same goes for unskilled workers.  (If we thought they were reading, we wouldn’t be using such an insulting term as “unskilled” to describe them.)

It seems to me that op-eds are better used to argue out which are the best policies to improve income distribution efficiently, and to point out who are the politicians who support them.  “Yes” to the EITC and pre-school education; “no” to subsidies for oil, agriculture and mortgage debt.

Too difficult, you say.  One must always apologize for the “policy-wonkery” of engaging in substantive discussion.  But think, what is the alternative?

Apparently the alternative is the very roundabout strategy of achieving more enlightened policies by trying to reduce the ability of the rich to buy votes, which is to be accomplished by reducing the share of income that goes to the rich, by reducing inequality, by… what?  Pursuing pro-equality policies, like the EITC and pre-school education!   How can complaining about inequality be a more effective strategy for achieving these policies than arguing the case directly for the policies themselves?

[A shorter version of this column appears at Project Syndicate.  Comments can be posted there.]

For more information on this publication: Belfer Communications Office
For Academic Citation: Frankel, Jeffrey.How to Address Inequality.” Views on the Economy and the World, April 24, 2014,