Liberal economists have it all wrong
8/3/2001 12:00:00 AM - Bruce Bartlett
In recent years, a number of left-wing economists have argued that inequality per se is harmful to many people's health. That is, the mere fact that some people are gaining income and wealth is harmful to others, even if the latter's income has not fallen or has risen more slowly. This argument is being used to justify income and wealth redistribution policies even when it results in slower economic growth or less national wealth.
Most economists have long believed that one's absolute level of income or wealth is the key to well-being, not his relative position. For example, suppose there are only two people in society and both start with the same income. One increases his income by 10 percent, the other by only 5 percent. Economists would say that since both are better off in absolute terms, it is good for society, even if one is now better off than the other.
This follows from an economic concept called Pareto optimality, which says any policy that makes at least one person better off without making anyone else worse off makes society as a whole better off. Generally speaking, if you tell most economists that a proposed policy is Pareto optimal, he will say, "Do it," without reservation.
Extreme leftists, however, may say no. They believe that the psychological pain of being relatively worse off is so severe that even Pareto optimal policies should be opposed if they increase inequality. One can perhaps understand this notion better if one thinks about one's children. If you give one of them $10 as a free and unexpected gift, but only give the other $5, you would probably be better off keeping the money in your wallet. Even though both are unambiguously better off, the one who got less will complain so bitterly at being short-changed, you will wish you had given them both $7.50 or nothing.
The point is that the egalitarian instinct is deep-seated. But should it drive policy? Should governments resist policies that make some people -- even many people -- better off at no cost to anyone else, simply because it increases inequality? During the recent tax bill debate, most Democrats said yes. They said tax cuts that lower every taxpayer's payments are wrong if they lower some people's taxes more than others. In effect, they said that it was better to have no tax cut at all than have one that lowered taxes for the "rich" more than the "poor."
Leaving aside the ambiguity of this argument, it is worth asking whether there is substance to it even if everyone could agree on terms. The same Democrats opposed an across-the-board tax-rate reduction, because those with higher incomes would by definition save more actual dollars in tax. They also oppose the tax rebate, which essentially gives the same dollar tax cut to everyone who pays taxes. What else is there between these extremes except no tax cut at all?
The same logic often applies to income generally. When the stock market was rising, left-wingers attacked the increase in inequality. They said it was painful for many Americans to see others getting wealthy, even if they themselves were no worse off in terms of their standard of living. But where are these people applauding the massive reduction in inequality that has resulted from collapse of the stock market since early last year? Why aren't they out celebrating in front of the New York Stock Exchange?
According to the Federal Reserve, the total value of corporate equities in the United States (including mutual funds) fell by more than $4 trillion between the 1st quarter of 2000 and the 1st quarter of 2001. Census data indicate that about 60 percent of all stock is owned by the top 20 percent of households. Those in the bottom quintile own just 5 percent of stock. Therefore, the fall in stock prices necessarily hurt the wealthy far more than the poor, causing wealth to become more equally distributed.
One would have thought the egalitarians got exactly what they wanted. About $2.5 trillion was, in effect, taxed away from the wealthy over the past year. Relatively speaking, the poor are much better off than they were a year ago. So why don't I hear the poor cheering? Aren't they happy that Bill Gates and Warren Buffett are only a million times richer than they are now, instead of 2 million as they were previously? I think not.
The collapse of the stock market has not benefited anyone except those who sold short at the peak -- a very tiny number of people, I am sure. On the other hand, it is clear that the fall has harmed many people who own not one share of stock. As a result, sales have fallen, companies have closed their doors and many people have lost their jobs. Whatever benefits people may feel from increased equality, I am sure it is far more than offset by the pain and suffering of those who are absolutely worse off because of the stock market's decline.