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January 19, 2012

Is Income Inequality Inevitable?

In a thought provoking post, Megan McArdle makes some points worth discussing:

I've said before that I don't care about income inequality per se, and that focusing on it seems more like institutionalized envy than sound policy. I care about the absolute condition of the poor--do they have the basics of a decent life? And I care about whether income inequality itself produces some sort of structural advantage in the political system. (I'm skeptical). But I don't care whether Bill Gates lives in a giant robot house that cost eighteen-squintillion dollars. What I care about is whether some kid is growing up in a roach infested shack with no heat--something that has basically nothing to do with the size of Gates' fortune.

On the other hand, income mobility is a very important issue. Regardless of how far the top is from the bottom, children born in America should have an equal chance to move from the latter to the former. This is especially important given that so many of the highest-paid jobs are also the most pleasant.

I'm less interested in Megan's main point than I am in the bolded statements excerpted above. Let's start with the first one:

I care about the absolute condition of the poor--do they have the basics of a decent life?

While I'm in general agreement with her here (I don't like the idea of starving children, seniors, or people of any description in America), the question of what constitutes the basics of a decent life is open to dispute. The idea that income inequality is bad per se rests on the dangerous assumption a decent life is not one where you have enough money to get by on, or even more than enough money to get by on.

The implicit assumption driving the income inequality debate is that a decent life is one where your neighbor doesn't have too much more than you do. The problem with this formulation is that if it's true, then government can't create a decent life for its citizens by raising their standard of living through government handouts.

When "a decent life" is defined as one where no one is allowed to have "too much" (too much income, too much profit, too much of anything), the only way to deliver a decent life is to reduce everyone to the same level.

Let's say the government were able to do that - equally distribute income so that no person or family had "too much" (whatever that means) more than another. Would such a policy eliminate economic insecurity or guarantee equal outcomes? Not while people remain free to make different choices about spending and saving:

One in three Americans would be unable to make their mortgage or rent payment beyond one month if they lost their job, according to the results of a national survey taken in mid-September.

Despite being more affluent, the poll found that even those with higher annual household incomes indicate they are not guaranteed to make their next housing payment if they lost their source of income.

Ten percent of survey respondents earning $100K or more a year say they would immediately miss a payment.

Now that is scary. I've written several times about how my husband and I lived below the poverty level for the first few years of our marriage. Despite being poor in the eyes of the federal government, we lived on one income. My husband attended college full time, and our savings account never dropped below $1000 - even when we had to pay a $700 non-refundable deposit for the privilege of not being turned away from the hospital when I went into labor, and even while paying $1900 in medical expenses out of pocket for my pregnancy.

We were able to meet these expenses easily and without using credit because we had developed the habit of saving. We did not spend every cent we earned and we never lived from paycheck to paycheck. What the linked article makes clear is that having "enough money" doesn't guarantee financial stability or security. If you don't have the foresight and self control to resist immediate gratification, your changes of moving up in the world are greatly reduced. Your inability (or refusal) to think ahead and plan for the worst makes you extremely vulnerable to bad luck.

One of the sad truths about both welfare and charity is that some people are their own worst enemies. Some parents, given more than enough money to live on, will choose to spend their income on recreational drugs. Despite having enough money to do otherwise, some people will choose to let their children live in Megan's roach infested shacks with no heat. Put this way, the real problem becomes clear. It's not money, but having the freedom to make bad choices.

The military provides a great illustration of how the freedom to make different choices produces unequal outcomes. Unlike the civilian world, in the military people of the same rank earn roughly the same income. Most people socialize with those of their own rank and in many cases military people live in housing, which equalizes large expenses like rent and utilities. Despite this, after a while you can't help noticing that some families are always short of money. Others manage quite well because they live within their means. And a select few (the 1 percent!) manage to build wealth through investment or even market speculation... all on the same income.

We knew one senior enlisted family who had 11 children. They lived in housing and to all outward appearances their standard of living was no lower than anyone else's. Their children were well dressed, well educated, and well mannered. The wife, unlike many military wives who claim not to be able to "get by" on their husbands' salary, did not work. They tithed 10% of their income and gave freely to charity.

Government can redistribute money from one citizen to another, but it can't force people to save for the future. There's no way to force people to budget and live within their means. So long as people are free to make bad decisions, equal incomes will not result in equal outcomes.

The second bolded point is important too:

"...income mobility is a very important issue. Regardless of how far the top is from the bottom, children born in America should have an equal chance to move from the latter to the former."

Once again, the notion of everyone having an equal chance is emotionally satisfying, but in the real world no two people have an equal chance of anything. We are unequal from birth. An ugly girl will not have an equal change of marrying. A clumsy and uncoordinated boy will not have an equal chance of being drafted by the NFL. A stupid person will never have an equal chance of being admitted to MIT. Even competitions between equally disadvantaged people will - due to luck, effort, or any number of other factors - inevitably result in unequal outcomes.

And there's nothing government can do to fix this. Nothing. Though it may be more accurate to say there's nothing government should do about it:

What could give rise to income inequality in the first place? Consider three males who graduated from high school in 1980 and worked full-time for the next three decades. (We use males and full-time workers only to abstract from variables such as changes in the gender composition of the labor force that could twist historical comparisons of earnings.) For one of them, education ends with high school, while the second gets a college degree and the third earns a graduate degree. In 1987, when these three were between the ages of 25 and 34, the average high school graduate earned $22,595, while a college graduate earned $31,631 and a holder of a graduate degree earned $36,667. But 20 years later, in 2007, the corresponding averages for male full-time workers ages 45 to 54 were $46,667, $88,242, and $120,391.

Unequal? Yes. But the increase in inequality arose because these individuals made different decisions about their education, not because tax policy favors the rich. In essence, economic inequality is another term for incentives that encourage investment in education—or, for that matter, starting a new business. Of course, most new start-ups fail, so there’s a lot of risk involved. But taxing the successful ones will not make failures less likely—and it will discourage the risky investments that are the engine of economic growth. Just ask your local lottery retailer if more tickets are sold when the prizes are large or when they are small.

The "We've got to make it easier for people to vote/go to college/major in STEM subjects..." meme has been popular in the news lately, but it proceeds from the faulty assumption that left to ourselves, we all make the same choices and it's only difficulty (or some other external force) that keeps people from getting ahead. The famous marshmallow test suggests otherwise. It suggests that the ability to resist temptation, defer immediate gratification, and plan for the future are critical to our ability to succeed in life:

These qualities are (generally speaking) strengthened by activities that teach patience, compromise, self denial, and the ability to evaluate tradeoffs. Examples include religious faith, participation in sports, and marriage.

Teachers are beginning to figure this out, but I'm not holding my breath waiting for government to follow suit.

Posted by Cassandra at January 19, 2012 07:57 AM

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Egalitarians create the most dangerous inequality of all -- inequality of power. Allowing politicians to determine what all other human beings will be allowed to earn is one of the most reckless gambles imaginable.
-- Thomas Sowell

Our Founders understood the matter, too: inequality of outcome necessarily follows from equality of opportunity, since not everyone is endowed with the same capability, or the same industry—the same degree of work ethic—or even the same degree of good or bad luck. For all men to be treated according to the equality of their endowment, the equality of their rights, they must be able to work fully to their own ends, and they alone must be able to reap the rewards of their efforts. The immorality lies not in the unequal results, but in the holding back of the one because others cannot, or choose not (vis., from laziness) to keep up, or the pushing forward of another when that other does not have the capacity to keep up on his own. The one is nothing more than punishment for success, and the other is nothing but an artificial success unrelated to his capacity or to his level of effort. Both actions are damaging to morality as both men are receiving that which they do not deserve on the basis of their actual performance—which follows from the equality of their opportunities—their natural rights.

And when government intervenes--always with the best of intentions--to control outcomes, it destroys both opportunity and upward mobility. Which also eliminates necessary downward mobility (at least as measured in relative terms), thus freezing today's rich in place, and locking out those who would have been tomorrow's rich.

Eric Hines

Posted by: E Hines at January 19, 2012 03:43 PM

PS: I feel for those kids. Resisting temptation is hard. Just ask Newt....

Eric Hines

Posted by: E Hines at January 19, 2012 03:44 PM

It's been a long, hard slog, with some rather spectacular (well, more accurately, *craptacular*) detours, but we're at a point where, were I to become unemployed tomorrow, I could liquidate sufficient assets to buy the mortgage, and still move on. I'd be a lot cash-poorer, but I still wouldn't have to sell a single gun, or SWWBO her spinning kit and the critters that feed it. Lets face it, what's important here?

Having been involved in supporting local charity work for a decade, I know relative and absolute poverty, and the difference. And the very different attitudes (in my experience) that go with it. The truly poor, assuming they aren't actually mental patients without proper supports, are grateful (but grumpy) about assitance, and oft times grimly and eagerly determined to be back on their own.

While the relative poor are living in the day-to-day with more stuff than we have, and a sense that they are entitled to have it and that it's my job to give it to them.

Just because it's a caricature doesn't mean it isn't true.

Posted by: John of Argghhh! at January 19, 2012 03:57 PM

I liked the little red head girl's "shut up and let me eat this marshmellow" approach. Decisive.

A couple of disjointed observations - I think the essence of freedom is freedom to fail, then try something else. Some people are naturally inclined to responsible behaviors, some never learn from their mistakes. I think most people have to feel a little discomfort to modify their actions. Income (or poverty) equalization taken to an extreme removes the mechanism most people use to learn. (Personally I like to find my limits by exceeding them - once I heal I know not to do that again. ;-)

How do you define poverty? I've known people in 3rd world countries who were extremely low income, but had the necessities - food, shelter and the means to control their immediate environment. Not much money, but they didn't seem to need much.

Posted by: Pogue at January 19, 2012 04:04 PM

I think most people have to feel a little discomfort to modify their actions. Income (or poverty) equalization taken to an extreme removes the mechanism most people use to learn.

I keep thinking of Sowell's observations that prices act as signals that convey information to both buyers and sellers. So do negative consequences, and when government interferes with that communication process, people forget why society has always encouraged certain behaviors and discouraged others.

Just as with price controls do nothing to control costs (but do affect quality and willingness of sellers to enter the market), reinforcing poor decisions doesn't get rid of the bad consequences that attend them - it just makes it harder to see the cause and effect connection.

Posted by: Cassandra at January 19, 2012 05:01 PM

Once again, the notion of everyone having an equal chance is emotionally satisfying, but in the real world no two people have an equal chance of anything. We are unequal from birth. An ugly girl will not have an equal change of marrying.

I read chance as opportunity not probability. True, a clumsy uncoordinated boy will not have the same probability of being drafted by the NFL, but no is trying to throw him in jail, fine him, or otherwise punish him for making the attempt either. He has the same opportunity to pursue, if not the same probability of achieving, his goal.

It may not be smart, but that goes back to the first point.

Posted by: Yu-Ain Gonnano at January 19, 2012 05:20 PM

Yu-Ain, I have missed you since C shut down.

Cassandra, if you keep listening to Thomas Sowell you're going to get all radical. What a clear-thinking man he is. I adore him.

Posted by: Texan99 at January 23, 2012 11:52 AM