David R. Henderson  

Bryan Caplan on Income Inequality

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The Power of Partial Derivatives

Bryan Caplan's reasoning on income inequality is correct. Some of the commenters who think they disagree are pointing to the fact that rich people are often honored and praised. That's correct. They often are. That doesn't at all take away from Byran's point. Take whatever level of honor, praise, and deference the top 1% get--and then add scorn and attacks. The net effect of adding scorn and attacks is to shift to the left the supply curve of those aspiring to be in the top 1%. Net result: the per person income of the people remaining rises.

The only way to challenge Bryan's argument is to challenge the view that scorn and attacks shift the supply curve to the left. Scorn and attacks would have no effect only if people were completely immune to those attacks; scorn and attacks would reduce their incomes only if people who aspire to be in the top 1% enjoy those attacks or, at least, use them as motivators. My strong gut feel is that Bryan is right about the direction of the effect on the supply curve.

I made a related point here:

[I]ncreasing marginal tax rates would increase measured inequality as long as the supply curve of high income earning labor is even slightly upward-sloping. The reason is that an increase in the marginal tax rate would discourage work. This reduction in the supply of labor would drive up the before-tax pay of the highest earners. All other things equal, their after-tax pay would decrease and after-tax inequality would fall -- but measured inequality would rise. One can easily imagine advocates of such a policy promoting even higher marginal tax rates on high earners on the grounds of "we didn't increase taxes enough to have an effect." Of course, the ironic result would be a further increase in measured inequality.

In the 1970s, when oil companies with large inventories of crude oil were being lambasted because of their record profits (funny how that happens when your inventory suddenly gains value due to a sudden increase in its price), politicians excoriated oil-company officials, hauling them before Congress to explain themselves. In various speeches I gave in the 1970s, I pointed out that to the extent this had any effect, it would be to increase the profit rates of oil companies.


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CATEGORIES: Labor Market



COMMENTS (11 to date)
david writes:

Not true; you also need assumptions on the nature of the substitution between high- and low-wage labour: trivially, if high-wage labour is too expensive and to achieve the same level of productivity I have to hire two low-wage labourers at a slightly greater total cost, this substitution would decrease inequality. The model doesn't constrain the number of people remaining in each labour market, only their effective status+wage compensation. This may or may not happen, of course; we don't know the relevant elasticities and Caplan hasn't suggested any.

(this is, by the way, exactly the same argument proferred to explain why unions support minimum-wage laws far below their own prevailing wages, i.e., that they benefit from labour substitution from low to high, at the expense of increasing inequality. It isn't a partisan argument.)

So it's not just elasticities of either. And we haven't even said anything about demand for labour. The model necessarily works in a pure partial equilibrium of high-wage labour but not in general equilibrium.

I note that I wrote a question about pre-tax inequality in the comments to Caplan's post...

Besides all that, I find it rather funny that the Caplanian relative-status model has zero elements of political rent. I suppose that only exists when discussing poor claimants of said rent ;)

david writes:

Actually, scratch "poor claimants"; perhaps it should be "claimants I dislike". Caplan should chat with his co-blogger about whether granting status increases or decreases resulting wages...

John writes:

The scorn heaped upon rich, successful people could very well shift the supply curve in those professions to the right: those who are sick of seeing rich scumbags in those professions could flock to those fields of study/business/industry to "clean up" the field and change things from the inside.

How many young economists have entered that field of study because of how poorly economists of the last 100 years have affected policy?

I know economists aren't typically in the top tier of income earners, but many of them receive scorn for non-envy-based reasons, so it seems that envy-driven scorn could drive the supply curve to the right as much as many other reasons.

Bryan assumes that the egalitarian scorn directed at the highest income earners will be (interpreted as being) directed at the profession and not the people, but that leap of logic might not hold water. If the egalitarian masses think that the people, and not the profession, are the problem, then that might motivate them to enter that profession in even higher numbers to do right where "rich scumbags" do wrong. Or at least it might not disincentivize them to enter it.

Neal W. writes:

But taxes and social derision have successfully been used to increase equality in Europe.

David R. Henderson writes:

@John,
Good point. That’s the way to challenge Bryan’s point. I think empirically it’s false because the OWS people I hear are heaping scorn on “the 1 percent,” i.e., anyone who makes enough money to put him in the top 1 percent, no matter what he did to get it. I don’t picture them trying to make a lot of money themselves. But your conclusion does follow from your premise.
@david,
I’ll think about it.

steve writes:

1) The scorn and attacks are a relatively new phenomena. Before the financial crisis, wealthy in the US received overwhelmingly positive coverage in the press and in day to day life. During that time period, inequality increased. Lifestyles Of The Rich and Famous aired from 1984-1995. Did inequality diminsh during that time period?

2) For the argument to work, you need evidence that high earners actually care about what others think about them. Did A-Rod offer to play for half price when told he was the best in baseball? Wouldnt it matter a lot more if the people you work with honored and praised you than the public?

3) I think that Bryan is almost right, he just looks at the wrong value. People who believe that what they are doing increases public welfare will often be willing to work for less. Others, like Wall Street traders and investment bankers who, other than Lloyd Blankfein, are not really doing God's work, rely upon financial rewards to vindicate their value and success.

4) I am still not convinced this is not parody. Are you two really serious about this? Fawn over Jamie DImon and he will take less salary? Really? How about the more likely reaction. "See, they are confirming that I deserve all of this and more."

Steve

David R. Henderson writes:

@steve,
Wow! You really missed the significance of my subtitle, didn’t you? The idea is that all else equal, an increase in scorn will increase pay of those who are scorned. For your historical period, not all else is equal.
Re your Jamie Dimon example, it takes a while. It’s not that Jamie Dimon offers to take less. It’s that a lot of people compete to replace Jamie Dimon.

Troy Camplin writes:

My take on Bryan's argument:

http://theliteraryorder.blogspot.com/2012/01/how-literature-can-reduce-income.html

Charlie writes:

I like this idea. We could raise marginal tax rates on the wealthy at no cost to growth, if we combined the policy with more social status.

It makes a lot of sense having someone like Warren Buffet ask for higher taxes. If enough 1 percenters did it, we could get higher taxes and raise the status of the 1%. Public policy meets PR campaign.

The argument also implies that if scorn/status is endogenous to the tax rate, then lowering top marginal tax rates may have no effect on incentives/growth. If President Bush (II) fighting for a big tax cut on the wealthy entering a recession made people more resentful of the top earners, it may have counteracted any incentive effects.

Brandon Berg writes:

To give a concrete example, many people who are otherwise intelligent enough to make a lot of money choose for ideological reasons to work in government, academia, or the private nonprofit sector, rather than "selling out" for a big paycheck. This reduces the supply of people willing and able to do lucrative but unfashionable work, making it even more lucrative.

steve writes:

" It’s that a lot of people compete to replace Jamie Dimon."

They dont now?

Steve

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