Should We Worry about the Rising Inequality in Income and Wealth?--Posner

Economic inequality is growing in the United States and other developed countries, and also in rapidly developing countries, notably China and India. Becker and I blogged about economic inequality on April 23, almost eight months ago, but indications that inequality is surging at the very top of the income distribution merits a further look, as does the recent study of world income inequality that is the focus of Becker's comment. Recent reports in the media document phenomenal returns to hedge-fund operators, private-equity investors, and other finance specialists, astronomical CEO salaries, enormous returns to software entrepreneurs, a stampede of lawyers and doctors to Wall Street, $200,000 law-firm signing bonuses for 27-year-olds who have clerked for the Supreme Court, enormous philanthropic gifts ($100 million gifts to colleges and universities by alumni are no longer unusual), and soaring demand for products bought only by superwealthy people, such as full-sized passsenger airliners converted at great expense to private airplanes, $40 million homes, paintings costing tens of millions of dollars, and automobiles costing several hundred thousand dollars. There are now almost 800 billionaires in the United States and countless millionaires, and one out of every 500 U.S. households have an annual income of at least $1 million. Now this is to look only at the top of the income distribution. It is not to consider the income distribution as a whole, let alone poverty. In the more conventional focus on earnings by quintiles, one sees little change in recent years. But since 1980 the percentage of total personal income going to the top 1 percent of earners has risen from 8 percent to 16 percent. It is the top of the distribution on which I’ll be focusing. What are the causes, and what are the effects, of this trend in the income (and of course wealth) of the highest-earning segment of the distribution? Part of it is reduced marginal tax rates, because high marginal tax rates discourage risk-taking. Consider two individuals: one is a salaried worker with an annual income of $100,000 and good job security, and the other is an entrepreneur with a 10 percent chance of earning $1 million in a given year and a 90 percent chance of earning nothing that year. Their average annual incomes are the same, but a highly progressive tax will make the entrepreneur's expected after-tax income much lower than the salaried worker's. Many of the people at the top of the income distribution are risk takers who turned out to be lucky; the unlucky risk takers fell into a lower part of the distribution. It is rich people as a class who are growing relatively richer, not necessarily individual rich persons. Marginal income tax rates on the wealthy have not declined much in recent years, however; but the income tax rate cuts since 2001 have favored the wealthy. Another and more important factor in the recent wealth surge is a growing return to high IQs; outstanding success in highly complex fields such as finance and software is highly correlated with high levels of intelligence. And increased size of markets as a consequence of increased international trade provides greater returns to successful innovations. I am more interested in the effects of the increasing incomes of the rich--though one might ask: are there any effects, other than those that are perfectly benign? Even though the federal income tax is increasingly a proportional rather than a progressive tax (though it is still somewhat progressive--the average tax rate for the top 1 percent of earners--24 percent--is roughly twice that for all federal taxpayers), the more skewed the distribution of income, the higher the proportion of taxes that is paid by the rich. And in fact the top 1 percent of earners pay more than one-third of all federal income taxes today, which is a boon to the rest of the population. Very wealthy people also provide patronage for the arts, funds for high-risk ventures (actually, art is one of those ventures), and money for philanthropic enterprises. And there is very little envy of the rich on the part of other Americans, in part perhaps because of the much-derided but very real "trickle down" effect. This is due partly to philanthropy but more to the enormous consumer surplus generated by products such as Microsoft Windows, the brainchild of persons who are now billionaires. It is also due in part to the fact that, given diminishing marginal utility of income, income increases at lower levels in the income hierarchy increase personal welfare more than increases at higher levels do. Moreover, real wealth is a function of improvements in the quality and variety of products and services, and these improvements benefit all classes of the population. All this is not to say that the existence of a stratum of exceedingly wealthy people is altogether to the good. There are three potentially bad consequences for our society: 1. The existence of enormous financial returns to IQ deflects high-IQ people from entering careers in which the social returns may greatly exceed the private returns: government service, basic science, and teaching. The quality of both the civil service and the public schools appears to be falling. 2. Massive philanthropy directed abroad can interfere with a coherent foreign policy. Major philanthropies such as the Gates Foundation do not coordinate their spending decisions with U.S. national goals. 3. Huge personal wealth may play a disproportionate role in political competition. Personal wealth confers an enormous advantage on a candidate, but also permits a person who does not want to be a candidate to exert an influence on candidates and policies, as in the case of Richard Mellon Scaife and George Soros. The fact that a person is a highly intelligent speculator, such as Soros, is no guarantor of political insight or wisdom; and the fact that a person has inherited a vast fortune, such as Scaife, is no guarantor of ability of any sort. More important, however, heavy campaign spending by the wealthy force nonwealthy candidates to spend increased time and effort on fund raising, which makes a political career less attractive to nonwealthy persons and makes nonwealthy politicians less well informed about policy and more dependent on interest groups than if campaign spending were lower. Are these consequences serious enough to warrant remedial action? I think not, except that they may provide some grounds for wanting to retain, perhaps even to strengthen, the estate tax. The disincentive effects of taxing estates are much less than those of income taxation.

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