Inequality — How much is too much?

What shape is the income distribution of Andrew Leigh’s dreams? Even he doesn’t know. "I don’t have a strong sense of what the right level of inequality is", he writes. "Indeed, I’m not even sure I have the right intellectual framework for answering the question."

The question is Andrew Norton’s. In the comments threat of recent post on ‘progressive fusionism’ he writes:

…‘progressives’ tend to think that there is a correct distribution of resources that can be decided in advance. However, in practice they tend to be very vague about what this correct distribution would actually look like. Andrew Leigh, for example, has written much about inequality of income, always with the assumption that less inequality is the correct outcome, but never saying what level of inequality would satisfy him.

So how should a ‘progressive fusionist‘ answer the question? The Cato Institute’s Will Wilkinson suggests that a new alliance of progressives and classical liberals might combine John Rawls’ ideas about justice with Friedrich Hayek’s ideas about markets. From this perspective, it’s not possible to decide on a correct distribution in advance. That’s because the question isn’t a purely philosophical one. On its own, Rawls’ theory doesn’t tell you what shape the income distribution should be.

Progressive fusionism?

‘Progressive fusionism’ is Brink Lindsey’s name for an alliance of American liberals and libertarians. He argues that both groups want to give individuals more control over their own lives:

The central challenge in cementing a new fusionist alliance–and, make no mistake, it is a daunting one–is to elaborate a vision of economic policy, and policy reform, that both liberals and libertarians can support. Here, again, both sides seek to promote individual autonomy; but their conceptions differ as to the chief threats to that autonomy. Libertarians worry primarily about constraints imposed by government, while liberals worry most about constraints imposed by birth and the play of economic forces.

The basic outlines of a viable compromise are clear enough. On the one hand, restrictions on competition and burdens on private initiative would be lifted to encourage vigorous economic growth and development. At the same time, some of the resulting wealth-creation would be used to improve safety-net policies that help those at the bottom and ameliorate the hardships inflicted by economic change.

Philosophically, Cato’s Will Wilkinson suggests, fortifying "Rawls’ theory of justice with a Hayekian grasp of the coordinating function of prices, and the dynamics of spontaneous order" or fortifying "Hayek with Rawls’ rather more intelligible normative framework".

Using Rawls’ theory of justice as an intellectual framework

Rawls was an egalitarian, but this doesn’t mean that he thought that income and wealth should necessarily be distributed equally. An important element of his theory of justice is the difference principle — a principle which tells us when we should favour a system that leads to greater inequality over one which leads to less. In a 1967 essay titled ‘Distributive Justice’, Rawls explained it this way:

The basic structure 1 is just throughout when the advantages of the more fortunate promote the well-being of the least fortunate, that is, when a decrease in their advantages would make the least fortunate even worse off than they are. The basic structure is perfectly just when the prospects of the least fortunate are as great as they can be (p 138).

On its own, Rawls’ theory says almost nothing about what shape the income distribution should be. To answer this question, we need to combine Rawls’ theory of justice with a theory which explains how alternative social and economic systems perform.

What if Hayek was right?

Egalitarians have been wary of markets for two reasons. First, markets inevitably create inequalities in income and wealth. Even if everyone starts out with equal quantities of human, social and physical capital, trade in the marketplace means that they will eventually end up with unequal shares of wealth and income (Robert Nozick explains why). Second, a pure market society leaves many people with little or no income. Those without assets who are unable to work, are forced to depend on begging, charity or foraging in garbage heaps.

As a result, egalitarians have often been attracted to socialism. Since the market is the cause of inequality and poverty, the less influence the market has on a person’s level of material well-being the better — or so socialists assumed. But Hayek challenged this assumption when he argued that a planned economy can never be as efficient as a market economy. This is because it is unable to use dispersed information as effectively. He argued, in effect, that attempts to engineer a patterned distribution of income will end up reducing the well-being of the least advantaged.

Rawls’ difference principle says that we shouldn’t trade off the well-being of the least advantaged in order to achieve greater equality in the distribution of resources. Hayek’s analysis says that the well-being of the least advantaged depends on a system that produces a significant degree of inequality. So if Hayek is right, Rawlsian egalitarians ought to choose a social system that includes market institutions and, as a result, sacrifices a certain amount of equality.

From a progressive fusionist perspective, the best systems would probably include a significant amount of income redistribution and government funding for services. Hayek supported both measures. In The Constitution of Liberty he wrote:

All modern governments have made provision for the indigent, unfortunate and disabled and have concerned themselves with questions of health and the dissemination of knowledge. There is no reason why the volume of these pure service activities should not increase with general growth of wealth. There are common needs that can be satisfied only by collective action and can be thus provided for without restricting individual liberty. It can hardly be denied that, as we grow richer, that minimum of sustenance which the community has always provided for those not able to look after themselves, and which can be provided outside the market, will gradually rise, or that government may, usefully and without doing any harm, assist or even lead in such endeavors (p 257-258).

How much inequality?

It’s difficult to know what set of rules and institutions would best satisfy Rawls’ difference principle. And unless you know what these rules and institutions are you can’t begin to model the resulting level of inequality. Everything from rules about corporate governance, intellectual property rights and the design of the income support system will influence the result. And on top of that the issue is further complicated by the fact that well-being is a broader concept than income or wealth (not to mention the problem posed by foreigners).

Personally, I suspect that the difference principle requires a combination of big government and free markets. But libertarians like Andrew Perraut think that this is only true in the short term:

… if markets are as massively productive as we libertarians believe and compounding returns to growth in the long term are taken into account, you could probably justify no more than very basic safety nets, for fear of distorting the economy and dramatically lowering everyone’s goods in the future.

Perhaps one way to have a more productive debate about these kinds of issues would be to use computer simulations — something like an economically sophisticated version of the computer game SimCity. Users could select their preferred rules and institutions and have the software simulate the way their hypothetical society might develop. Since the simulation would apply economic theory to generate the outcomes it would be more interesting if users had a choice of theories to play with. Users could experiment with different tax and welfare regimes and watch as GDP grew or contracted, poverty rates rose or fell, and citizens chose to stay or leave.

What’s the point?

While philosophy students might enjoy debating the similarities between Hayek and Rawls, is this debate likely to influence real world politics? There are two reasons for being sceptical. The first is that few people either know or care about Hayek and Rawls. And this includes most politically active classical liberals and left-leaning liberals. Even at the great purple heart of the left wing Australian blogosphere, Rawls has few supporters. Similarly, most libertarians and classical liberals have only a vague idea of what their Austrian hero actually wrote.

The second problem is that political movements form around policies rather than principles. As the philosopher Richard Rorty argued, "Principles are useful for summing up projects, abbreviating decisions already taken and attitudes already assumed." What they are not useful for is creating new movements. People who change the world often form alliances with others who agree with them on what to do but disagree about why.

Rorty argues for something that sounds a lot like Andrew Leigh’s experimental approach to reform. As usual Rorty credits the idea to another philosopher:

John Dewey hoped that democratic politics would cease to be a matter of batting plausible but contradictory principles back and forth. He hoped that it would become a matter of discussing the results, real or imagined, of lots of different social experiments. The invidious comparisons I am suggesting amount to saying: Look, a lot of good experiments have been run, and some of them have been pretty successful. Let’s give them a try.

But it’s worth remembering that the link between practice and principles is two way. People decide what policies are likely to produce good results based on their ideas about how the world works. And, in turn, the results they get shape their ideas. For example, think about how the experience of stagflation in the 1970s changed people’s minds about Keynesianism.

Part of what keeps a new progressive alliance from forming is that people mistake differences in ideas about how the world works for differences in moral principles. Left-leaning liberals look at the policies classical liberals support and assume that the motivation is to redistribute income from the poor to the rich. And classical liberal look at left liberals and assume that they are motivated by an envious desire to punish the rich even if it means making everyone worse off.

Starting a conversation about principles may be the best way to challenge these assumptions and encourage the two groups to start working together on new policy ideas. Maybe we should try it and see what happens.

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James Farrell
James Farrell
14 years ago

Thanks for making the effort to formulate something on this topic, Don. There’s two issues that shouldn’t be confused, however. It shouldn’t be that hard to come up with a degree of income inequality that reconciles fairness with the need for material incentives. Orwell in The Lion and the Unicorn suggested ten to one; I imagine that five to one would be enough to extract the maximum effort from anyone who needed that motivation, though of course it wouldn’t work in just one country. (As an aside, I don’t think the burden of proof has to be on supporters of inequality, to show that it’s desirable. To me it’s self evident.)

The much harder problem is how to design a set of rules that would preserve such a distribution. Even with very high marginal tax rates on individuals and inheritance taxes, you would still end up with a tail of very rich people, due to windfalls, inventions, and clever dealings. The most we can practically achieve without creating too much bureaucracy and surveillance, and without breeding too much resentment is a decent living wage at the bottom end, with a Scandinavian welfare state and minimum wages (via government wage subsidies if necessary.)

Nicholas Gruen
Admin
14 years ago

Thx Don,

I enjoyed reading the post.

NPOV
NPOV
14 years ago

I’d suggest taking the average GINI co-efficient of the 10 countries in the world with the highest HDI as a start. Which would make Australia’s pretty good (and the U.S.A’s pretty bad).
The correlation between GINI co-efficient and HDI to me is pretty good evidence of the advantage of aiming for a reasonable GINI. Has anyone got a good scatter-plot showing this? I’m sure I saw one not long ago.

skepticlawyer
14 years ago

I’ve written a paper on this topic for jurisprudence; unfortunately it’s due on the 18th of April, so I’m not in a position to make it public until it’s been handed in. Someone give me a nudge if I forget and I’ll put it up over at the Cat.

conrad
conrad
14 years ago

I’m not at all convinced about GINI coefficients. First of all, I think the main problem is to do with the extreme left of the distribution, rather than the entire distribution. Second, there are government policies that make huge differences to the real poor which have nothing to do with the coefficient. Places like HK have a much higher coefficient than Australia, but half population lives in public housing. Given this, I’d rather be poor in HK than richer and homeless in Australia — and the coefficient says nothing about these sorts of things.

NPOV
NPOV
14 years ago

That’s definitely true, but it’s still about the best measure out there. And one or two exceptional cases (and there is a fair bit that is exceptional about Hong Kong) don’t invalidate a general guideline.

Also, I’m not entirely sure the wide availability of public housing in HK does make the situation better for the poor there. Surely it would be better if they had enough money to afford housing of their own choice? Of course land is such a premium in Hong Kong that no other solution may be viable.

Ultimately it has to be up to each country AND its citizens to decide what they want – ideally through democracy. Which is of course one area where Hong Kong fails rather miserably – so we have no real way of knowing whether most citizens of Hong Kong would prefer a government that aimed for reducing inequality.

Don Arthur
Don Arthur
14 years ago

James – That’s an interesting point.

I think the biggest confusion is to think we need inequality primarily to extract the maximum amount of effort from workers.

It seems to me that major problem isn’t to stop workers from shirking but to make sure that resources go to where they are most valued. Milton Friedman put it this way:

A system based on private property and free markets is a sophisticated means of enabling people to cooperate in their economic activities without compulsion; it enables separated knowledge to assure that each resource is used for its most valued use, and is combined with other resources in the most efficient way.

The examples I always think of are intermediate goods — goods that are used to produce other goods. How would government planners know how to allocate these goods in the absence of price signals?

As you say, once the system is in motion it starts to generate a long tail on the right — for all kinds of reasons.

Personally, I think the shirking problem is a distraction. It’s more of a within-firm problem than a system design problem.

hc
hc
14 years ago

Personal expressions of the need for redistribution suffer from biases. Public goods biases – the cost is spread around but individuals think mainly of the possible costs of their own contributions. Also hypocrisy biases – in the main its a hypothetical exercise in which it is easy to exaggerate your willingness-to-pay. In fact people can redistribute whatever fraction of their income they choose now without any public intervention by means of private charity. That they don’t do so with generosity suggests hypocrisy and public goods biases.

Rawls is ludicrous in spite of the ‘difference principle’. Consider two societies. Society A has 20,000,000 people with income $100,000 and 1 person with income $5,000. Society B has 20,000,000 people with income $2,000 and 1 person with income $5,001. I think Rawls says society B is better off which no-one with common sense would agree with.

Patrick
Patrick
14 years ago

A good post which I enjoyed reading.

Perhaps one way to have a more productive debate about these kinds of issues would be to use computer simulations something like an economically sophisticated version of the computer game SimCity. Users could select their preferred rules and institutions and have the software simulate the way their hypothetical society might develop. Since the simulation would apply economic theory to generate the outcomes it would be more interesting if users had a choice of theories to play with. Users could experiment with different tax and welfare regimes and watch as GDP grew or contracted, poverty rates rose or fell, and citizens chose to stay or leave.

We will get these kinds of experiments once we start settling in space – but I fear we might have to wait until then! I can’t help but think that any computer modelling of such sophistication would only recreate certain assumptions which would skew the result. But computers might easily develop enough to encompass that.

And back on the progressive fusionism:

Left-leaning liberals look at the policies classical liberals support and assume that the motivation is to redistribute income from the poor to the rich.

This is often enough expressly stated by left-leaning liberals so I am willing to believe it is true.

And classical liberal look at left liberals and assume that they are motivated by an envious desire to punish the rich even if it means making everyone worse off.

This may be true. But I don’t think it is ‘serious’. I think the real issue is that classical liberals look at left liberals and think that they must be ideologically blinded to have so much faith in untested (or indeed tested and failed) ideas and so little regard for evidence.

There are several exceptions to that and Andrew Norton lists most of them in his post. But on the whole, support for trade barriers and ‘fair’ trade, high marginal tax rates, anti-vilification laws and other such furphies are a prima facie proof to many liberatian-minded liberals (the ones in which you place so much hope) of either mental infirmity or ideologically blindness, basically.

The much harder problem is how to design a set of rules that would preserve such a distribution.

I agree, as I expect does everyone! Personally, I would opt for a strong bias in favour of lesser barriers to change and bad choices but with targeted compensation for the ‘losers’ (or in some cases, merely ‘bad choosers’, which doesn’t mean we should let them die). In general, I think that leads one perhaps somewhere inbetween Australia and Danish ‘flexicurity’.

Don Arthur
Don Arthur
14 years ago

I think Rawls says society B is better off

Harry, I’m intrigued. Why do you think that?

Joshua Gans
14 years ago

I suspect Harry meant to add one more zero to the $2,000.

NPOV
NPOV
14 years ago

hc, that people don’t voluntarily sacrifice a certain percentage of their income to aid in redistribution isn’t surprising. For a start:

a) Much of the time, it’s a hassle. I just want it done automatically. After a while anything that’s a hassle you tend to attempt to avoid.
b) There’s very little point in me voluntarily giving my income to others if I’m on the only one to do so. I need to be sure that everyone else who can afford to will participate in the scheme.
c) I don’t have enough time, expertise or information to determine who will best benefit from my voluntarily sacrificed income. Most likely I will give it to some cause that happens to appeal to me on a fairly irrational basis. Now of course I accept that governments don’t always do a great job of spending public money, but that is their job, and we elect them to do just that. So it’s surely logical to give my money to the government, and hold them accountable (via the various democratic institutions) to doing that job well.

On that basis, I would be reasonably happy to volunteer to pay a little more tax than I do. Unfortunately, there’s not very many ways I can actually do that (whereas there’s literally dozens of ways I can legally reduce my tax burden considerably). Further, if I was going to volunteer to pay more tax, I would want a little more say over how it was spent (or at least, to be guaranteed it wasn’t spent on projects that I strongly disagree with).

hc
hc
14 years ago

Don, Because the worsrt off sections of society are better off under B

Patrick
Patrick
14 years ago

a) Much of the time, its a hassle. I just want it done automatically. After a while anything thats a hassle you tend to attempt to avoid.

Fair enough. Nick Gruen loves this topic, and indeed there are a few books on it.

b) Theres very little point in me voluntarily giving my income to others if Im on the only one to do so. I need to be sure that everyone else who can afford to will participate in the scheme.

This is ridiculous. I said above that classical liberals don’t really believe that left liberals believe in class war but maybe I was wrong. Isn’t the point that if you believe we should all give more to the poorest people the you should do so anyway? Are you driven in fact by concern for your relative position?

c) I dont have enough time, expertise or information to determine who will best benefit from my voluntarily sacrificed income. Most likely I will give it to some cause that happens to appeal to me on a fairly irrational basis. Now of course I accept that governments dont always do a great job of spending public money, but that is their job, and we elect them to do just that. So its surely logical to give my money to the government, and hold them accountable (via the various democratic institutions) to doing that job well.

This is even more ridiculous. Can’t you hold yourself accountable? Can’t you focus your investments in a particular charity and hold them accountable? And on the theme of your last paragraph, wouldn’t giving to government come with a guarantee that much of the money would be spent on things you would not have personally chosen to spend it on?

Don Arthur
Don Arthur
14 years ago

Society A has 20,000,000 people with income $100,000 and 1 person with income $5,000. Society B has 20,000,000 people with income $2[0],000 and 1 person with income $5,001.

Even some people who agree with Rawls’ general approach (choosing principles from behind a veil of ignorance) find the difference principle intuitively implausible.

It’s worth noting that idea of Pareto optimality runs into the same objection. In a 1968 essay of distributive justice Rawls wrote:

… the difference principle satisfies the principle of efficiency. For when it is fully met, it is impossible to make any representative man better off without making some other man worse off, namely, the least favored representative man. Thus it defines a conception of distributive justice that is compatible with Pareto optimality.

I don’t think Rawls would talk in terms of one society being ‘better off’ than another. What he was interested in was whether a society’s basic structure was just.

Rather than asking readers to choose between end-states, Rawls asked them to choose between the sets of principles that generate them. He argued that if the principles are just then nobody can complain about the outcomes.

But I take your point. Many people don’t find the difference principle intuitively appealing.

swio
swio
14 years ago

Perhaps one way to have a more productive debate about these kinds of issues would be to use computer simulations something like an economically sophisticated version of the computer game SimCity. Users could select their preferred rules and institutions and have the software simulate the way their hypothetical society might develop. Since the simulation would apply economic theory to generate the outcomes it would be more interesting if users had a choice of theories to play with. Users could experiment with different tax and welfare regimes and watch as GDP grew or contracted, poverty rates rose or fell, and citizens chose to stay or leave.

This already happens all the time. That’s what economic modelling is. It has two major problems.
1) Only an economist has enough expertise to run these computer simulations. Would you trust a computer model of climate change run by a philosopher?
2) The bigger problem is these models are completely dependent on the underlying economic theories. Again comparing to climate change, a model of the Earth’s climate would not work if you did not have Boyle’s Law, and many other carefully worked out laws that have been proven in the laboratory over literally centuries.

This problem actually goes to the heart of almost all debates about social/economic issues today. Alot of the theory in economics is too vague or too uncertain to be useful in the real world. The world’s most emminent economics professors disagree, often quite fundamentally, about even basic questions like the effect of tax rates on growth. If the experts don’t have a consensus that produces reliable and proven laws for predicting economic variables then the rest of us can do no more than cherry pick opinions from particular economists that suit our own biases. This problem is central to the debate about libertarian ideas on society as liberatarians believe that lack of government is, in the long run, vastly more efficient and hence will produce so much more wealth that questions of distribution don’t become important. But is that a testable hypothesis? Is that a proven statement? No, its just an opinion supported by view of some economists. Its like philosophers arguing about the age of the universe 50 years ago when half the world’s astrophyscists believed in steady-state thory and the other half believed in the big bang.

Having said all that, there is a way you can conduct computer models that might answer these questions. Massive multiplayer online games like World of Warcraft, Second Life or Eve-Online are creating enormous virtual economies with millions of real participants where things like tax rates could be played with without causing disruption to the real world. The results would be alot more reliable because they would come from the actions of real people making real decisions about resource allocation rather than theories that are still subject to debate.

NPOV
NPOV
14 years ago

Yes, we should give more to the poorest (specifically, give them enough that they have the same sort of opportunities that we have), but it’s human nature to avoid schemes where free-riding and cheating is too easy. I’m not saying it’s a good reason for me to personally avoid giving more to charity, but it’s just one of the reasons that people are likely to be wary of voluntarily charity – they ask themselves (consciously or otherwise) “why should I personally give up my money for the betterment of society when nobody else is”?

As for point c), as I said, it is quite specifically the government’s job to be responsible for spending public money. It’s a significant amount of hassle for me to “focus [my] investments in a particular charity and hold them accountable”. Seeing as I don’t personally suffer from my voluntarily sacrificed income being spent poorly, there’s little motivation for me to make an effort to monitor it constantly. Whereas governments have a significant motivation for spending public money wisely: i.e. the ballot box. So on that basis, it’s hard to see how wealth redistribution would work better if it was entirely voluntary, regardless of how much more fair or noble it might seem.

Regarding having more control over how my taxes are spent – yes, I would like to see this option. At least one person has seriously floated the idea of voters having a say on the budget: i.e. how much they think should be spent on various parts of it. Obviously it’s impractical (and foolish) to hand this entirely over to voters, but I can certainly see the merits in such a scheme.
For instance, if I could specify that my taxes were to be mostly spent in the general areas of education, arts, public transport, health etc. and not to be spent on defence or certain industry subsidies, then I’d happily volunteer to pay more of them.

swio
swio
14 years ago

From a progressive fusionist perspective, the best systems would probably include a significant amount of income redistribution and government funding for services. Hayek supported both measures.

It must be remembered that Hayek was writing in a time when socialism was widespread and it was not clear that communism doesn’t work. Alot of what he was arguing against no longer even exists today. It is my reading that the anti-government position of libertarianim today is probably well beyond what Hayek himself envisioned. In other words, finding that Hayek might support alot of progressive policies is, perhaps, not nearly the same thing as saying that a Libertarian would.

Nicholas Gruen
Admin
14 years ago

Partrick,

I think you’re throwing round the word ‘ridiculous’ too much. For me anyway, poverty alleviation is a public good.

Even that doesn’t quite capture the way people think and are motivated on redistributive issues. People’s other regarding nature is so strong that if engaged it’s worth a lot more than tithing. Witness parents working their guts out and going without themselves to provide for their families – this is quite normal.

Why do they do it? Are they that altruistic? They do it because of a powerful mix of culture and biology. It makes this behaviour normal, expected and so on.

At the societal level people feel exactly the same. This is true in spades of course in wars. Social solidarity is a powerful glue – so powerful that Hayek saw people’s natural sense of community solidarity as the enemy of the market. And as Bowles and Gintis report that there’s no great resentment towards taxes when it’s felt that they’re supporting the ‘deserving poor’. People are happy sacrificing to lift the ‘deserving poor’ in the community up. But most won’t be happy doing it if they think others are free riding on their efforts.

They will feel the same as a sibling who’s left to look after some poor member of their family – say an old sick father – when other siblings don’t contribute.

It’s of the essence of this situation that these obligations are felt socially – not just individually.

Jc
Jc
14 years ago

Why should anyone waste their time worrying inequality if the economic pie is growing.

Patrick
Patrick
14 years ago

I think youre throwing round the word ridiculous too much. For me anyway, poverty alleviation is a public good.

The former might be true. But I happen to agree with the latter as well?

Theres very little point in me voluntarily giving my income to others if Im on the only one to do so.

From your comments, Nick, I understand that NPOV wasn’t talking about a ‘point’ after all. Mea culpa, and your points are quite valid. But what NPOV actually wrote does seem ridiculous to me.

As for his comments about government not being a necessarily good allocator of money but then again neither is he, really, so government should spend it because then he can vote for or against them, whereas he (presumably) can’t actually keep himself or some smallish charity accountable??? It still seems ridiculous to me!

PS: you say:

People are happy sacrificing to lift the deserving poor in the community up. But most wont be happy doing it if they think others are free riding on their efforts.

but I thought the ‘free riding’ in question was that of welfare receipients not taxpayers.

Very happy to be corrected on that!!

Jc
Jc
14 years ago

Lewt me ask anyone here if there is an upper limit in terms of what the government’s take ought to be? We’re currently at around 33%. Should it be more. How much more?

I would guess that a lot of people would disagree with Milt’s suggestion that the total government take ought to be no higher than 10% or his comment:

A society that puts equality ahead of freedom will end up with neither equality nor freedom.

NPOV
NPOV
14 years ago

Jc, what’s the use of an economic pie that’s growing if there a significant number of people that are not benefitting particularly from it?

At any rate, inequality in wealth leads to inequality in power, and consequently to exploitation, corruption, and social unrest. Human nature’s a bitch.

As far as the % of GDP that government’s should be responsible for taxing and spending, there seem to be plenty of European nations whose citizens seem perfectly comfortable with it being close to 50%. Who’s to say they’re wrong?

hc
hc
14 years ago

NPOV, You can easily have regular deductions made from your salary by the bank and paid to the Salvos or any other reputable group.

You are wrong to say there is no point in you making an individual contribution. There might be greater aggregate effects if everyone pays but, if that does not happen, your individual contribution is worth more than it would be if everyone contributed since it can be directed to the very needy – those at the top of the queue in terms of need.

The ‘I won’t give unless others do’ is a pretty safe way of limiting your payments since they won’t do so voluntarily and will only do so if subjected to a tax – then you will have to give anyway. It costs you nothing to advance this claim.

I have no response to point c. It sounds self-contradictory to me. You don’t trust goverrnment but you will trust them on this one. In a privatised set-up many of the publicly-funded benefits paid to the most needy are paid via private charities anyway.

Are you sure you are not a ‘welfare hypocrite’ who gets a warm inner glow from telling the world how much you care for the poor and needy but need to invent implausible excuses for not doing so? Join the club – it has a vast membership – most of the human race.

NPOV
NPOV
14 years ago

hc, agreed, I overstated in implying that there was no point in me making a contribution if nobody else does. I’m more interested in looking at the reasons people (consciously or otherwise) might use for not donating as much as they can afford.

I didn’t say I don’t trust government, just that they “dont always do a great job of spending public money”. I wouldn’t even say I trusted them any less or any more than private charities, but at least I know that the government is constantly under pressure to spend money sensibly, whereas I’m not so sure that charities always are.

I don’t think I particular make a point of telling the world how much I care for the poor and needy: I would just like to know that I live in a world where the least fortunate of us (which may well include me at some point in the future) still have access to opportunities to improve their lives, and aren’t readily exploited by those with the wealth and power to do so. My motives are as selfish as anybody else’s.

melaleuca
14 years ago

HC says to NPOV:

“Are you sure you are not a welfare hypocrite who gets a warm inner glow from telling the world how much you care for the poor and needy but need to invent implausible excuses for not doing so? Join the club – it has a vast membership – most of the human race.”

True. And that is why I prefer Government to coerce money out of my pocket to provide for social welfare. That way I’m not tempted to find excuses for not giving money to private charity. While I do give to private charity, I could afford to give much more but don’t do so because I readily succumb to personal greed.

As to Joe’s question re tax, when an individual is earning more than ten times the minimum wage I’d like to see them taxed at about 70%. I’d increase that to 95% at twenty times the minimum wage.

Jc
Jc
14 years ago

Ok, so that’s a starting point, N. You think the government take ought to be closer to 50%.

You would achieve that by raising even more income taxes on those people that are currently paying the bulk of income taxes?

You understand that you would be raising the governments take by 50% The effect of this is that you would be making a transfer towards increased consumption at the expense of investment: the very thing that would eventually lower living standards.

Jc
Jc
14 years ago

Credit where credit’s due. At least Mel and N are being honest and forthright in terms of where they want to see things.

NPOV
NPOV
14 years ago

I assume melaleuca you mean that every dollar earned over 20 times the minimum wage (~$250/hr, or nearly $500,000/yr) should be taxed at 95%? Tax rates that high did use to exist some time ago, but I’m not sure there’s a lot of evidence that anyone ever paid them.
I suspect once marginal tax rates get over 50% the motivation to avoid them become too high for them to be terribly useful. There are surely better ways to redistribute wealth.

Jc
Jc
14 years ago

Ummmm should read

You understand that you would be raising the governments take by 100%

Nicholas Gruen
Admin
14 years ago

Patrick,

People don’t like free riding. It may well be this intense dislike of free riding leading to what’s called in the jargon ‘strong reciprocity’ that’s an integral part of what got us going as a viable species.

We will punish those who we feel are ripping us off, even if it harms us – wars are one of the best examples of strong reciprocity.

People intensely dislike free riding whether of the undeserving poor or the undeserving (ie non-contributing) non-poor.

NPOV
NPOV
14 years ago

Actually Jc, no I don’t particularly believe that Australia would benefit by raising the government tax take that high. In fact, I don’t think there’s a huge need to increase it all – just to spend it better.

Andrew Leigh
14 years ago

Don, a classically great post. Though I’m still not sure if Rawls, Hayek, Lindsey and Norton can tell us whether Australia’s gini of 0.31 (or if you prefer, our 90/10 of 4.2 or our Atkinson One index of 0.17) is too high or too low. The great inequality philosophers frame our thinking. But when it comes down to the ‘does Australia have too much or too little?’ question, I’m still left puzzling.

NPOV
NPOV
14 years ago

Also, Jc, would would a higher tax take imply “increased consumption at the expense of investment”? Australians are pretty lousy investors. OTOH, most areas of public spending I would think qualify as investments.

I also accept that a much higher government tax take would put something of a brake on the rate of economic growth. But if the choice is between a medium sized pie divided up reasonably equally, and a huge pie where a few get most, and the rest fight for the scraps, I’ll go for the medium sized pie any day. Even if it potentially means I personally end up with a smaller piece.

NPOV
NPOV
14 years ago

Bleh, make that “why would”, not “would would”.

Andrew, is “Australia’s gini” supposed to be a link?

melaleuca
14 years ago

NPOV says:

“I suspect once marginal tax rates get over 50% the motivation to avoid them become too high for them to be terribly useful. There are surely better ways to redistribute wealth.”

That’s true. An alternative is to target the spending and assets of the rich and whack them with hefty death duties. I’m not fussed as to which method is employed.

NPOV
NPOV
14 years ago

Relevant article by Ross Gittins Lloking at some studies that examined how much people would voluntarily put towards a common pool of funds that benefitted others more than themselves: http://business.smh.com.au/selfishness-goes-only-so-far-we-also-like-a-fair-system/20080321-20wb.html?page=fullpage#contentSwap3

Russ
14 years ago

JC, my first thoughts on that question was that it depends on how much inequality you have. In a society where everyone had the same income then the optimum tax take for reducing inequality is probably zero (there will, of course, still be taxes for public goods).

As soon as you move away from an equal society, and an economic model of an equal society then it is reasonably easy to see situations where some segments are out-bid for important goods by richer segments satisfying their desire, rather than a need. So your question is essentially (and obviously) political: what basket of goods and services should everyone have access to regardless of wealth. It is also going to be strongly orientated towards the tail of the distribution. I don’t have much else to offer on the political front. Inequality matters, but I can’t say how much.

Two other things come to mind though:
1) Assuming there is an efficient political equilibrium of welfare taxing, any society that increases equality (regardless of cause) should reduce their welfare tax rate. And the corollary, any equalizing society that doesn’t reduce their tax will probably distribute the benefits of welfare more broadly. Somewhere in that there is an empirical test.

2) In relation to NPOV’s point on the economic pie. Changes to the welfare tax rate in the long term will depend on expectations and are therefore political. In most cases expectations will rise, and so will the rate. But in the short term they will depend on the inter-relation of growth, inequality and inflation. That is, assuming you have economic growth, there are nine possible combinations of increasing/decreasing equality, and inflation/deflation (over/under changes in the wage-rate) that will affect whether people still have access to the politically acceptable basket of goods:

1-4. Rising/stable equality, zero or negative inflation

When economic growth decreases (or maintains), not increases inequality. Any time it does this the tax rate can be reduced, because situations are improving.

5/6. Increasing inequality/stable equality, inflation

Conversely, increases in equality and inflation are reducing the relative position of people through no particular fault of their own, and the tax rate needs to rise to compensate for those losses.

7-8. Increasing inequality, zero or negative inflation

The situation where the rich are enjoying the benefits of growth, but where the welfare of others hasn’t decreased, and may even be improving. This is the case that seems to cause divisions in left/liberal positions, but it is arguably not a stable state; as the benefits trickle down, either/or both inflation will rise and/or equality will rise again.

9. Rising equality, inflation

In this scenario things might be improving or regressing, so there is no clear answer. However, it is also a situation likely to lead into slower growth as wage rates and inflation rise together, so other factors may be more important.

Arguably the Howard government had that combination of growth, stable equality and zero-negative inflation that allowed them to reduce the tax rate. Arguably too, they didn’t reduce it enough when they had the chance, resulting in wide-spread middle class welfare. Certainly the Rudd government appears to be facing a different situation.

Patrick
Patrick
14 years ago

Mel

An alternative is to target the spending and assets of the rich

Also known as a GST – easily the most progressive tax available.

and whack them with hefty death duties.

also easily avoided.

But such punitive taxation as you impose would not work, whatever the format. No-one taxable would live in Australia in such an environment, basically, and in short enough order nor would anyone else interested in more than subsistence.

Nick
Thanks. I can understand that, although I still think that the free riders Bowles and Gintis were talking about was welfare recipients and not welfare providers.

Don Arthur
Don Arthur
14 years ago

Andrew Leigh (at 33) – I’m curious, why do you think it’s worth constructing and using measures like the gini index?

Is it because they measure something inherently important, or is it because you can use them in theories that explain changes in other variables?

NPOV
NPOV
14 years ago

Patrick, explain how the GST can possibly be the most “progressive tax available”?
I’d like to see some numbers to back such a claim up – you seem to be implying that the rich spend a far higher percentage of their income on goods and services than the poor.
(FWIW, I think there are many good arguments in favour of a GST, but progressivity doesn’t strike me as one of them).

NPOV
NPOV
14 years ago

FWIW, http://www.smh.com.au/news/business/taxes-giveth-as-gst-taketh-away/2005/07/08/1120704557532.html mentions a study that ranked the GST as -0.017 on the progressivity index, making it definitely regressive. However, the GST package as a whole was no less progressive than what it replaced.

Andrew Norton
14 years ago

“Though Im still not sure if Rawls, Hayek, Lindsey and Norton can tell us whether Australias gini of 0.31 (or if you prefer, our 90/10 of 4.2 or our Atkinson One index of 0.17) is too high or too low.”

I’m sure they can’t, because as Don’s point implies it does not of itself matter what any of the indexes are. It’s up to the people calculating these numbers to explain why the results are important.

Andrew Leigh
14 years ago

NPOV, my apologies. It was a link to the comparative inequality estimates compiled by the Luxembourg Income Study folks. See: http://www.lisproject.org/keyfigures/ineqtable.htm. If we’re talking cross-national inequality, it’s the best source.

Don, I like the Gini because it has an intuitive explanation – it’s half the average income gap, expressed in terms of mean income. So a gini of 0.31 implies that the after-tax household income of any two random Australians differs on average by 62% of mean income. Mean household income in a recent ABS survey was $644 per week, so the mean income difference between two random people on the street would be $399.

But I think your question was really about whether that number has special meaning to me, and the honest answer is probably that it only matters in the context of comparing it to Australia in 1981 (G=0.28), Sweden today (G=0.25) or the US today (G=0.37). Thinking more about this, I guess it implies that if measured inequality was the same in all places and times, I’d be stumped to know what to do when you told me the level of inequality.

Patrick
Patrick
14 years ago

NPOV, sorry, my line didn’t quite make sense. A GST is a part of the most progressive solution available – that is a GST with a low-income credit.

Poor people spend a far greater percentage of their income on goods and services, but it is so little money in real terms that they are cheaply and easily compensated through the transfer system. No matter how rich rich people are, however, they basically can’t avoid GST. Cutely, if they even try, they incur GST on their efforts :)

So a ‘perfect’ quick ‘n easy tax reform might be to lower the top marginal rate to 30 per cent, increase the GST to 20 per cent (common in Europe anyway) and introduce a GST rebate for people earning up to $35,000 and progressively decreasing from there.

That would be progressive in practice, even if on tax:reported income ratios it might look less progressive.

NPOV
NPOV
14 years ago

Patrick, that sounds reasonable enough to me. In fact, any simplification of the tax system that reduces the tax avoidance (and the cost of tax compliance) and doesn’t make anyone earning less than the median income worse off works for me.
Oh, I don’t think there’s a good justification for reducing the total tax take at this point in time.

Don Arthur
Don Arthur
14 years ago

Its up to the people calculating these numbers to explain why the results are important.

I think Andrew L is invoking the Banana grower’s response:

ME: You sure grow a lot of these Cavendish bananas. How come?

BANANA GROWER: I like them because they’re resistant to Panama Wilt disease. You can identify them by the size of the pseudostem …

ME: Yes yes. But what’s good about bananas?

BG: You can sell them.

ME: Right. But why would I want to buy a banana?

BG: I’m a banana grower not a mind reader.

NPOV
NPOV
14 years ago

Andrew L, thanks for that. I was using http://en.wikipedia.org/wiki/List_of_countries_by_income_equality, which seems a bit more comprehensive.

What I actually find surprising is that there are no genuinely third-world countries with very low GINI co-efficients. Using the UN measure, the lowest recorded is that of Denmark, followed by Japan and Sweden. The only truly poor country with a low GINI is Ethiopia (30%). OTOH, the only country that isn’t a genuinely third-world country with a high GINI is South Africa (57.8%).
The correlation between high levels of inequality and high levels of social unrest seems to jump out too, but accepted we can’t automatically conclude that it’s a causal relationship.

Backroom Girl
14 years ago

it only matters in the context of comparing it to Australia in 1981 (G=0.28), Sweden today (G=0.25) or the US today (G=0.37).

My problem with measures of income distribution is that I think they conceal as much as they reveal. You see, I don’t at all know whether today’s Gini coefficient of 0.31 is ‘worse’ than 1981’s 0.28.

This is because I think that there is so much more diversity in the ways that households put together their income now that you are more likely to be comparing apples with oranges than apples with apples. And having meaningful comparisons of disposable income depends on being able to compare apples with apples.

One of the main problems as I see it is the ‘equivalence scales’ that are most commonly used to adjust household income to take account of household size and composition. As time has gone on, these have become simpler – possibly to make it easier to equivalise income and to do all of the poverty research that some of us are so addicted to. So most people now use the ‘modified OECD’ equivalence scale, which allocates a value of 1 to the first person in a household aged 15 and over, 0.5 to each other person aged 15 and over and 0.3 for each person aged under 15. This gives you a household equivalence factor that you can use to adjust your data on earnings, total gross income or disposable income. Other equivalence scales involve using the square root (ie a household of four requires twice as much income as a household of one) or even the cube root of household size (a household of eight requires twice as much income as a household of one).

So that’s all simple then. The only problem is that there is no allowance in these simple formulae for the kinds of things that actually make important differences to standard of living – for example, home ownership or the number of people in the household who work. So the ‘poverty line’ for a household with no workers and living in their fully-owned home (eg most aged pensioners) is exactly the same as a same-sized household that pays private rent and has two people going out to work.

All other things being equal, a society where household employment conforms closely to a single norm (eg 1950s Australia with one full-time adult earner per household or Scandinavian countries with two full-time earners per household) will have a more equal income distribution than a country like Australia now where there is great diversity of household employment patterns -all the way from jobless households on the one hand to households with 2+ full-time earners on the other.

Now, I grant you that having too many jobless households is not a good look (though many people in the welfare industry nevertheless staunchly defend the right of single parents, for example, to be jobless), but for most employed couples in Australia the intensity of their employment participation is largely a matter of choice. And generally we pride ourselves on the fact that parents of children in particular are able to choose when and how much they want to work. So how can we get upset if a development such as that has been accompanied by more income inequality?

Backroom Girl
14 years ago

And don’t get me started on the quality of income data in Australia – something to bear in mind when comparing Australia with other countries, where the income data is more likely to be sourced from administrative collections (tax, employment insurance records etc). Organisations such as ACOSS who think that we have a poverty rate of somewhere between 10 and 20% would do well to remember that even the ABS has no faith in the quality of data in the lowest decile – they use the 2nd and 3rd deciles as the low-income comparison group in their own analysis.