The Problem With Income Inequality

I happened upon this piece yesterday from Scott Winship about some recent regressions he ran on cross-country income inequality. The bit relevant to my post here reads as follows:

My analyses focus on inequality before governments redistribute income through progressive taxes and cash transfers. Another reason that inequality does not tend to lead to lower living standards in the developed world is that below the top 1 percent, inequality before taxes and transfers does not vary much across rich countries. By the most used measure, inequality within the bottom 99 percent is barely higher in the United States than in Denmark.

This is one of those things where you bang on the specification until you can generate some figure to down play inequality in the US. That's sort of been Winship's main task since he left Brookings. The US 1% pulls down a monster share of the national income relative to other developed countries. Further, the US has a puny tax and transfer level relative to other countries. Clear out those main drivers of inequality and you can sort of say inequality isn't so high (though actually still higher even under that specification).
 
This is a rather odd way to make the point that we don't need to up transfers (or as he prefers to call them "redistribution"). Saying that under certain specifications, pre-transfer inequality in the US is similar to pre-transfer inequality elsewhere does not tell us that we don't need transfers. If anything is going to render that conclusion, it would be a finding that our pre-transfer inequality is pretty similar to other countries' post-transfer inequality. If that were the case, then maybe you really could say there is no reason to bother.
 

Winship disagrees, saying that although he sort of said something as silly as this in the conclusion of his paper, it was a mistake and that this one mistake doesn't knock down the rest of the paper.

So I took a look at the rest of the paper to see whether this was the case. But it's not just a stray remark in the conclusion that goes down these muddled lines.

Right from the beginning, Winship explains:

An important distinction in looking at “income” is the distinction between market and disposable income. The concern that income inequality hurts the living standards of the poor and the middle class is implicitly one about the inequality produced by markets, that is, inequality before government redistributes income via taxation and transfers. The fear is that market economies produce high inequality that is only partly remedied through redistribution. [...] Inequality of disposable (posttax and -transfer) incomes will tend to correspond with low living standards below the top only because taxes and transfers do not fully mitigate even higher market income inequality. This paper therefore focuses on inequality measures that reflect the distribution of market income.
 
This is not at all what people are worried about in most inequality circles. The concern that income inequality hurts the living standards of the poor and middle class is not implicitly about inequality produced by markets. The concern is that high disposable income inequality (relative to other countries) is strong suggestive evidence that the bottom and middle could be made better off by increasing taxes and transfers. That is to say, where disposable income inequality is high, that suggests there is money out there going to the rich that could be hoovered up and shot out to the non-rich.
 
This suggestive evidence is actually bolstered by the fact that other countries have similar levels of market inequality. If other countries got to be more equal primarily because of their market distribution of income, it could prove very difficult to replicate. Making the market distribute out the national income in a different pattern is a tough task for a lot of reasons. The fact that other countries achieve their lower disposable income inequality through non-market programs is thus extremely promising. After all, if they can transform the same level of market inequality into a lower level of disposable income inequality by adopting a certain set of social income institutions, why can't we do the same thing?
 
Nordic countries, which have the highest living standards for the bottom of any other set of countries in the world, do not have especially low market poverty rates. On average, their market poverty rates are just 1.2 percent points lower than ours. Yet, from that similar market poverty "starting point," they manage to secure dramatically lower levels of disposable income poverty, especially for children (which they focus the most effort on). 
 
 
In fact, even children of single mothers (the great bogeyman of the Right) don't fare that much better in the Nordics in the market, but have a much higher standard of living after social incomes are counted:
 
 
To reiterate: when two sets of countries have the same market income inequality, but one set has much lower disposable income inequality, that's a good indication that simple changes in distributive institutions could do wonders for the more unequal country. When it comes to the US and the Nordics (which Winship notes are doing the best in this regard), adopting tax and transfer institutions that are similar in form to what the Nordics have should significantly improve the standard of living of those at the middle and especially those at the bottom. The further fact that economies in the Nordic countries grow at about the same rate as the US economy throws even more fuel on that fire because it indicates that, at least when they do it, there is no obvious efficiency/equality trade off involved.
 
The concern about inequality has very little to do with the market distribution itself (the market is, after all, just a creature of policy, a government program like any other). Rather, the concern is that high and rising inequality signals that we are throwing away opportunities to relieve the want and humiliation of the bottom (and to a lesser extent, the middle), and are opting instead to shovel more and more of the national income to the rich for no good reason.

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