Income Inequality, Taxes, and Incentives

In yesterday's New York Times, Ian Ayres and Aaron Edlin make a provocative proposal for taxing not the wealthy per se but inequality.  They rightly point out, as does Robert Frank in his new book The Darwin Economy, that extreme inequality produces all sorts of negative consequences for society (from felt deprivation to health, education, and democracy).  Inequality in the U.S. is quickly approaching developing country levels (we have long been the outlier among OECD countries), and Ayres and Edlin argue that the current trajectory could lead to serious social disruption.  They note that average income of the richest 1% is currently about 36 times median household income.  They propose an inequality tax tied not to absolute income but to the ration of a household's income to median income, effectively capping total income at the current position of 36 times median household income.  Just as we have a minimum wage, they propose a maximum wage.

The idea of relating income to national medians is intriguing and suggests other possibilities as well.  Perhaps we could use it to incentivize (to use the language of executive compensation) our elected officials by having congressional pay linked to median incomes (at 1:1 or 1:2).

Kim Il Sung and Mao Tse Tung in Maputo

The corner of Kim Il Sung and Mao Tse Tung Avenues; Maputo, Mozambique

Capitalism, Sustainability, and Inequality

Jon Shayne sent me an interesting piece by economist Kenneth Rogoff, who asks "Is Modern Capitalism Sustainable?"  Rogoff points out that the alternatives to U.S. style capitalism these days are limited to other flavors of capitalism: Northern Europe's compassionate capitalism or China's cut-throat authoritarian variety or any number of other possibilities.  These ultimately boil down to the balance of regulation and laissez faire, between public goods and private rewards.

In previous posts I have extolled the virtues of the German Soziale Marktwirtschaft, and I think Rogoff is too casually dismissive of European model's as being unsustainable.  But he rightly points out key flaws in our own system: undervaluing public goods, growing inequality, provisioning healthcare, discounting the future, and magnified risk.  And these are all things the German system does pretty well.

On the topic on inequality, Jon also passes along a great Paul Solman report on why conversatives are generally happier than liberals--and it is not just a greater tolerance of (and even appetite for) inequality, but a belief in the availability of opportunity and of meritocratic advancement.  If folks have (or even just believe) that opportunities are open to them, they are much more content with their lives (whatever their own present circumstances).    

Amartya Sen has argued that real economic development is about freedom more than income: the freedom to live the sort of life one values.  Central to this conception are opportunity structures (as well as the material resources and agency needed to effect change).  In a study of poor farmers and peasants in rural Mozambique, my colleague Bart Victor and I found that personal ambitions and resources with no outlet, with no opportunity structure to facilitate action, results in "frustrated freedom" and low subjective wellbeing. 

The happiness difference between liberals and conservatives in the U.S. therefore might well be in how open they perceive available opportunity structures. 

What Latin America Can Teach the US about Inequality

Jorge Castaneda, writing in today's New York Times, offers a view of "What Latin America Can Teach Us" in in terms of income inequality.  He observes that just as income inequality has been on the dramatic rise in the U.S., Latin America, thanks to a growing middle class, has seen a significant decrease in inequality.  This is especially true in Brazil, where programs such as Bolsa Familia have elevated families from abject poverty to consuming lower middle class.  Inequality is still very high, much higher than the U.S., but the inequality measurement the Gini index has been declining steadily.  And we can see it in the growing consumer market for cars, refrigerators, and other hallmarks of entering the global middle class.

The UN Economic Commission for Latin America (ECLAC) recently released its annual poverty figures.  They show that 30.4% of Latin Americans live below their national poverty lines, a steady decline for a peak of 48.4% in 1990.  With rapidly growing GDPs in Brazil, Mexico, Peru, and elsewhere, and with the ongoing success of conditional cash transfer programs, the future looks good for the region in terms of equality.  Yet, deeper investments in the quality of education and healthcare will be needed to keep these trends moving in a positive direction.

Castaneda argues that the effects of extreme inequality are felt for decades or generations.  This is especially clear in terms of nutrition and education, areas that contribute centrally to human capital but that take a long time to show the rewards of investment, or the setbacks from neglect. The US should, therefore, be worried about rising inequality and its effects on social solidarity as well as economic competitiveness and productivity.