The talk about inequality has turned from ethical issues (should the rich be so rich) to economic impacts, such as whether inequality means economic stagnation. A recent report by Standard & Poor’s economists highlights this attention. In this series of articles, I first address the differences between inequality and poverty, then discuss four possible impacts of inequality that have economic implications: lower consumer spending, more likely end to growth spells, social friction and political control by the rich.
Inequality or Poverty?
Inequality is not the same as poverty. Inequality is the difference of incomes among different people or households, whatever the levels of incomes. Poverty is having a low income. It’s possible to imagine a society which is uniformly poor, and thus perfectly equal, or a society with wide variation of incomes but nobody in serious need.
Consider possible policies to alleviate inequality. Many who have weighed in on the subject would like to move income from the upper one percent or ten percent and transfer it to the lower ten percent or twenty percent. That would reduce both poverty and inequality, if it really worked that way.
Efforts to equalize incomes among different people may reduce total income, as the economist Arthur Okun noted in his classic book Equality and Efficiency: The Big Tradeoff. Okun says, “The money must be carried from the rich to the poor in a leaky bucket. Some of it will simply disappear in transit, so the poor will not receive all the money that is taken from the rich.†The bucket leaks for two reasons. First, higher tax rates on the rich reduce their incentive to work while increasing their incentive to use tax avoidance schemes. Second, higher support for the poor reduces their incentive to work. For example, a recent Congressional Budget Office report found that for incomes in the range of $5,000 to $20,000 per year, the next effect of earning an extra dollar is only 15 cents, because of the phase-outs of so many safety net programs. As a result, many lower-income families make the rational decision to work less than they otherwise might.
