Income Inequality Revisited

By Marian L. Tuoy

Thursday, March 04, 2021

 

When administrations change, so do the government’s priorities. The Trump administration, like most Republican administrations, emphasized economic growth as a means by which American workers, especially blue-collar and unskilled laborers, could see an increase in their income and, consequently, their standard of living. To that end, the last administration pursued deregulation and corporate-tax reform. The Biden administration, by contrast, has chosen to put a renewed emphasis on tackling income inequality — a common theme in the Obama years. To that end, the new administration hopes to increase corporate and personal income taxes as well as legislate a higher federal minimum hourly wage. The question is: Does income inequality matter? And if so, why? 

 

In psychology, the theory of social comparison (or status anxiety) holds that what matters to many people is not an absolute improvement in their well-being — how much better off they are than they were previously — but their well-being relative to the people around them — how much better off they are than their peers. Human nature provides some evidence for this theory, but our genetic predisposition for thinking in relative terms should be kept in proper perspective.

 

To start with, not all human impulses, including those to lie and steal, are laudable. To think otherwise would be to commit the naturalistic fallacy (i.e., to argue that if something is natural it must be good). Also, the evidence from nature is far subtler than is commonly understood. What matters to a person, let’s call him “X,” is not whether he is outperformed in any random domain but whether he is outperformed in a domain that is important to him.

 

There are, in fact, two competing forces at play. X wants to be a part of a successful group. Belonging to such a group during the time of evolutionary adaptation would have allowed for more successful hunts as well as greater protection from predators and enemies. In other words, X wants his peers to succeed. But there is a countervailing evolutionary pressure having to do with one’s relative position within a group, which is brought about by sexual selection: Group members who obtain a disproportionate share of resources are able to attract more-desirable (e.g., healthier) mates and thus have a better chance of passing their genes on to future generations.

 

So, X will feel good if he can outperform his peers in a domain that’s important to him. That will increase his chances of finding a mate. Conversely, he will feel bad if he is outperformed by his peers in a domain that’s important to him. That will decrease his chances of finding a mate and perpetuating his line. In brief, the inclinations of modern-day people are the result of their ancestors’ competing against natural forces and strangers for survival but competing against peers for sex.

 

The most common resolution to the two competing forces is for X to admire his peers when they do well in the domains that are not very important to him and envy them when they outperform him in a domain that is important to him. If X’s peers outperform him by a sufficient margin in all domains, X will lose much of his mating potential and status within the group and become envious and unhappy.

 

The theory of social comparison, then, points to a real psychological phenomenon: In certain situations, some people will care about income inequality more than about absolute improvements in their own standard of living. But is this a serious problem that requires the urgent attention of our elected officials? In fact, measuring the effect of income inequality on people’s subjective well-being yields surprising results.

 

In 2016, sociologists M. D. R. Evans and Jonathan Kelley analyzed the effects of income inequality on the subjective well-being of over 200,000 individuals in 68 societies in the period from 1981 to 2008. They found “that in developing nations inequality is certainly not harmful but probably beneficial, increasing well-being by about 8 points out of 100.” That’s because “in the earliest stages of development some are able to move out of the (poorly paying) subsistence economy into the (better paying) modern economy; their higher pay increases their well-being while simultaneously increasing inequality. In advanced nations, income inequality on average neither helps nor harms.” Only in ex-Communist countries did an increase in income inequality reduce the subjective well-being of the older generation that grew up under Communism while increasing (or having no effect on) the subjective well-being of the succeeding generations.

 

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If it can’t be shown that income inequality reduces people’s well-being in advanced countries, such as the United States, where does the new administration’s emphasis on income inequality come from? To be fair, plenty of Democrats (and some Republicans) seem genuinely concerned that great wealth differences can pervert the democratic process and skew economic policies in favor of the super-rich. On that point, it is useful to look at some pertinent numbers.

 

To start with, it is surely reasonable to expect the super-rich to give their financial support to candidates promising to decrease the former’s tax burden. Yet that’s not what happened in the 2020 presidential campaign. Forbes noted that for every Trump-supporting billionaire (there were 133 in total), Biden was supported by 1.73 billionaires (230 in total). And, according to the Federal Election Commission’s year-end numbers, the Biden campaign managed to raise $1.074 billion while the Trump campaign managed to raise “only” $812 million. The super-rich, in other words, tended to favor a candidate explicitly promising to make them financially worse off.

 

Moreover, the Organisation for Economic Co-operation and Development (OECD) noted that U.S. income taxes are among the most progressive in the world. The latest data from the Tax Foundation show that the share of federal income taxes paid by the top 1 percent of earners rose from 33.2 percent in 2001 to 40.1 percent in 2018 (an all-time high that was reached after the Trump tax reform). In 2018, according to the foundation’s summary for that year, the “top 1 percent paid a greater share of individual income taxes (40.1 percent) than the bottom 90 percent combined (28.6 percent),” and “the top 1 percent of taxpayers paid a 25.4 percent average individual income tax rate, which is more than seven times higher than taxpayers in the bottom 50 percent (3.4 percent).”

 

The supposedly outsized influence of the super-rich on U.S. electoral politics, in other words, appears to have failed to deliver meaningful tax relief for the super-rich under recent Republican and Democratic administrations alike. That is partly why, when it comes to taxpayer-funded social spending (i.e., on health, old age, disability, family, the active labor market, unemployment, and housing), the United States is no laggard. U.S. social spending in 2019, for example, amounted to 18.7 percent of GDP — more than the figure in Australia (16.7 percent), Iceland (17.4 percent), Canada (18 percent), and the Netherlands (16.1 percent), and only a little less than the OECD country average (20 percent).

 

Let us now move beyond the theory of social comparison and the supposed effect of big money on politics and look at some of the ways in which a renewed focus on relative income inequality might be counterproductive in the real world. First, preoccupation with income inequality risks normalizing envy — a happiness-destroying emotion condemned by all the main religions and moral codes. There is nothing wrong with income inequality, provided that it was fairly arrived at. Most people understand, for example, that the wealth of Apple co-founder Steve Jobs was the result of the entrepreneur’s vision and hard work. Jobs, in other words, did not steal his money. He earned it by creating value for others. The proper lesson to derive from his achievement ought to be inspiration, not envy.

 

Second, income inequality is, in many ways, the midwife of progress. People who break from the pack by developing an innovative, useful product such as an iPhone can become very rich, but by adopting the new product the society as a whole profits and moves forward. The same is true of new modes of social cooperation, production processes, etc. Put differently, progress would be impossible if society prevented people from trying out and benefiting from new things. Just think of what the world would look like had the Luddites stopped the industrial revolution, or of the future of humanity if innovation of new drugs and sources of energy were to be throttled by the precautionary principle (i.e., risk avoidance).

 

We can make our consideration of Jobs’s wealth and the social benefits resulting from his innovations more concrete. The Nobel Prize–winning economist William D. Nordhaus has concluded “that only a minuscule fraction of the social returns from technological advances over the 1948–2001 period was captured by producers, indicating that most of the benefits of technological change are passed on to consumers rather than captured by producers.” Based on “data from the U.S. nonfarm business section,” Nordhaus estimates “that innovators are able to capture about 2.2 percent of the total social surplus from innovation.” When Jobs died, he was worth $7 billion. If Jobs’s $7 billion represented 2.2 percent of the social value that he created, then the other 97.8 percent of the social value that Jobs created and passed on to Apple consumers amounted to $311 billion. Similarly, the total market value of Apple stood at $2.26 trillion at the beginning of 2021, implying a social benefit of over $100 trillion that was passed on to consumers of Apple products. We can also look at the social value created by Apple from the sales and profits perspectives. In 2019, Apple’s sales amounted to $260 billion, implying a social value of $11.5 trillion. That year, Apple’s profit amounted to $55 billion, implying a social value of $2.45 trillion.

 

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Finally, focusing on income inequality rather than absolute improvements in the standard of living can be psychologically destructive, for there will always be people who have more money, more things, better health, higher intelligence, better looks, greater height and strength, more charisma, etc. “One secret of happiness,” notes the economist Richard Layard in his book Happiness: Lessons from a New Science, “is to ignore comparisons with people who are more successful than you are: always compare downwards, not upwards.”

 

Layard’s observation works not only in the present but also inter-temporally. Pretty much everyone in the past had a quality of life that was inferior to the quality of life enjoyed by the vast majority of people in advanced societies today. In 1924, for example, the son of a U.S. president died of a bacterial infection in a blister on the third toe of his right foot. The blister had developed when Calvin Coolidge Jr. played tennis on the White House lawn with his brother. “Many of the best doctors of the day were consulted, multiple diagnostic tests were run, and he was admitted to one of the top hospitals in the country,” as my Cato Institute colleague Chelsea Follett has written, yet “he died within a week of infection. . . . Deaths from sepsis following the infection of a minor cut or blister were extremely common at the time and no amount of wealth or power could save a patient.” Coolidge’s son died just four years before the discovery of penicillin by Alexander Fleming.

 

What this suggests is that people without historical perspective are at a massive disadvantage. Instead of being grateful for all the good things in their lives, they are resentful because of the things that they lack but others have. Acquisition of a historical perspective is not only prudent from a logical standpoint (i.e., it is the best way to measure progress) but also conducive to happiness. People with a historical perspective can ponder ways in which they could have been worse off (e.g., being a peasant in 17th-century France) rather than ways in which they could be better off (e.g., sipping champagne with the glitterati during Paris Fashion Week).

 

All in all, it is tempting to conclude that tackling income inequality is a solution in search of a problem. As a political matter, it is pressed primarily by a vocal minority of (mainly) Democratic activists, some of whom may be driven by envy, while others may be preoccupied with the illusory influence of the super-rich on the democratic process.