Income Inequality Not Necessarily Inequitable

February 27, 2013

Typically, the top 1 percent of income earners is lambasted for increasing their income at a time when the rest of the population is experiencing a decline in their income. This approach is misguided and fails to consider the facts, says Richard Epstein, a senior fellow at the Hoover Institution.

  • Income for the top 1 percent has increased by 11.2 percent while the overall income of the rest of the population has decreased slightly by 0.4 percent.
  • It is important to realize that gains for top income earners are acceptable as long as they did not come from taxation of individuals at the bottom.
  • The idea for this view comes from the concept of Pareto efficiency, which says that an action is good as long as it results in a net gain for one person without making anyone else worse off.

Contrary to the popular contention that a heavy concentration of income at the top is harmful, the 1 percent can increase their income so long as it is Pareto efficient. Consider a scenario where 99 percent of the population makes $10 and the top 1 percent makes $100. In the second scenario, 99 percent of the population makes $12 and the top 1 percent makes $130. Though the income gap increases in both absolute and relative terms, everyone is better off in the second scenario.

  • Recent tax policies are one likely reason why income at the top was higher in 2012, as the top 1 percent, who are heavily invested in financial instruments, liquidated more assets in 2012 to avoid higher 2013 tax rates.
  • Some economists favor redistribution during economic downturns, like the 62 percent marginal tax rate during the Great Depression, and champion government leveling as a mechanism that promotes income equality.
  • Favoring redistribution ignores the fact that there is no way to make the poor richer without making the rich poorer.

Indeed, it seems that regulation and taxation actually serve to make everyone poorer. President Obama has proposed to increase taxes on the wealthiest and raise the minimum wage. Instead, the best economic approach to benefit the middle class would involve flattening the income tax and deregulating labor markets.

Source: Richard Epstein, "In Praise of Income Inequality," Hoover Institution, February 19, 2013.

 

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