There has been news and conversation about economic inequality and economic growth lately, mostly because the former is increasing steadily and the latter has been less than stellar.
Of course, there is always a tension between economic growth and equality. Economic growth implies at least some inequality. That’s because most people need incentives to create things people value. They need a reward. Creating perfect equality necessarily eliminates incentives.
The reward for innovation or effort doesn’t have to be the full value of an innovation or effort. The person who invented the wheel did not collect the present value of the innovation. Similarly, Bill Gates, rich as he is, or the late Steve Jobs, or George Mitchell, the man who helped developed “fracking” did not collect the full value of their innovations. The fact that people voluntarily agree to pay income taxes demonstrates that they don’t have to consume the full value of their effort. So, there is room for some redistribution.
Still, there has to be some reward, some incentives to work or innovate. That incentive naturally will create inequality.
Call incentive the supply side. If there is a supply side, there must be a demand side. There is, and that comes from people, but it is not what you might think.
Economic theory is based on the concept that people are happier when they consume more or better products. That turns out to not be true. People are no happier than they were 100 years ago, and we consume a lot more than our great-great grandparents.
The fact is that since the 1950s in America, and now in many parts of the world, people have been free of the worst Malthusian constraints. We have plenty to eat and on some measures we don’t really need any more. Especially with current low birth rates, not just in advanced countries but also in much of the developing world, consumption growth is unnecessary.
So, why do we need economic growth?
We need economic growth because people need more than consumption.
The great cartoonist Al Cap, the creator of Li’l Abner, understood this. Li’l Abner, his wife Daisy Mae, and the other residents of Dogpatch sometimes benefitted from the presence of a creature called a Shmoo. Shmoos bred prolifically, and could create or serve as anything humans wanted. They were perfectly happy, ecstatic in fact, to be dinner. With Schmoos around, all human consumption needs were fulfilled, with no effort on the part of the humans. It didn’t work out so well. The Shmoos were eventually killed by extermination teams to save humanity and the economy, except for two saved by Li’l Abner and returned to repopulate the Valley of the Shmoon.
We have similar real-world examples, and it doesn’t work out so well here either. It turns out that when all consumption needs are provided with little or no effort on the part of the recipient, something is lost. Drug and alcohol abuse abounds in these populations. Traditional families are destroyed. Crime is high. Violence, including domestic violence, is high. Morals are abandoned. Relationships are fluid, frequently violent, and always temporary. Health is poor, even when healthcare is provided.
It turns out that when people are provided everything they need, self-destructive behavior is the norm. It’s almost as if they have no reason to live, and it is a terrible price to pay for consumption.
It turns out that a job costs less than dependency, and that’s why we need economic growth. Jobs and opportunity provide us with some things that consumption can’t. I think those are pride, dignity, and purpose.
That doesn’t mean we should abandon the effort to provide a safety net. People are different, and few of us would be comfortable with the how the least endowed would live without a safety net. It is also true that the gods of chance can be cruel to even the most capable. Most of us would like to see some protection provided the unlucky.
A safety net reduces inequality, and is redistributive. The trick is to maintain incentives.
If we are to offer people jobs and opportunity, and we must, we need economic growth. To realize economic growth, we need to maintain incentives for the most productive and innovative. Punitive marginal tax rates are counterproductive.
How support is delivered to the recipients is also extraordinarily important. The incentive issue should be paramount. We owe it to the recipients to provide the support in a manner that preserves dignity and pride and always provides a healthy incentive to work. Far too many existing programs have effective marginal tax rates near, at, or exceeding 100 percent. This easily happens on means-tested programs, where the next dollar in income could cost the benefit plus the taxes on the new income. Here’s a quote from a report by the Employment Policies Institute:
“As an example, in states with ostensibly generous welfare benefits, Professor Shaviro shows that a single mother with two children could increase her earned income from $10,000 per year to $25,000 per year and actually find herself with 2,540 fewer dollars once she accounts for lost tax credits and benefits. Though her earned income more than doubles, she is worse off financially.”
It makes no sense to have 100 percent marginal tax rates on high-income individuals. It makes even less sense to have 100 percent effective marginal tax rates on the least advantaged.
Bill Watkins is a professor at California Lutheran University and runs the Center for Economic Research and Forecasting, which can be found at clucerf.org