Why pre-tax inequality matters

Does pre-tax inequality matter? I ask because of a dispute between Aditya and Tim. Aditya says that inequality is back at 1920s levels - which is true if we consider the share of the richest 1% - to which Tim replies that the relevant metric is inequality after taxes and welfare benefits:

What we really want to do is measure the distribution after we’ve changed it. For only after we’ve checked how much we have changed it can we decide whether we want to change it some more.

However, I suspect that pre-redistribution inequality does matter.

For one thing, market rewards are linked to the esteem in which we hold ourselves and others; there's a reason why wages are called "earnings." The rich get respect from others and a sense of self-worth and arrogance, whilst those reliant upon "hand-outs" feel despised; this is why the unemployed are so unhappy, even controlling for (pdf) their low incomes. I would have expected a senior fellow of the Adam Smith Institute such as Tim to know this, as this is what the great man wrote:

This disposition to admire, and almost to worship, the rich and the powerful, and to despise, or, at least, to neglect persons of poor and mean condition...[is] the great and most universal cause of the corruption of our moral sentiments...
We frequently see the respectful attentions of the world more strongly directed towards the rich and the great, than towards the wise and the virtuous. We see frequently the vices and follies of the powerful much less despised than the poverty and weakness of the innocent. (Theory of Moral Sentiments I.III.28)

Mere monetary redistribution doesn't solve this problem. Indeed, it might even exacerbate it, by making the rich feel that they are being deprived of their entitlements in order to support "scroungers". In this sense, inequality can lead to distrust, as Eric Uslaner has written (doc):

When some people have far more than others, neither those at the top nor those at the bottom are likely to consider the other as part of their “moral community.”  They do not perceive a shared fate with others in society.  Hence, they are less likely to trust people who may be different from themselves.

This matters, because trust is a significant influence upon economic growth.

Worse still, the high opinion the rich have of themselves tends to be shared by politicians. One of the more unpleasant aspects of New Labour was its deference towards bosses which led Gordon Brown to commission endless policy reviews from them, and in the US there's a revolving door between Washington and Wall Street. In this sense, pre-tax inequality of incomes generates an anti-democratic inequality of influence and political power.

But there's another reason why tax and benefits aren't sufficient to reduce inequality. A tax and benefit system does not distinguish between the sources of incomes. An income that is derived from rent-seeking, exploitation or cronyism is taxed as much as one obtained through talent and effort. James Crosby and J.K. Rowling are taxed similarly. But there's surely a difference between them.

Now, you might read all of this as a criticism of Tim. But that's not my main point. My point instead is addressed to the soft-brained left; higher taxes and more generous welfare benefits are nothing like sufficient to tackle inequality.

Comments

[nibs]

excellent post. Interestingly the Swiss, fresh from a referendum curbing golden handshakes and parachutes for executives, may soon vote on salary ratios between the highest and lowest paid within enterprises. This could be interesting.

[Metatone]

Pre-tax inequality is a measure of power distribution - and that matters a lot.

[ricketson]

I think Metatone summed it up well -- the income differences represent differences in control over resources (whether through ownership or having a high-rakning office). A lot of non-income perks come from such differences. These perks are both material and social.

[Mat]

I'm a bit baffled by your point here Chris.

Surely Post-tax creates pre-tax; Higher earners (def; net payers) will bargain for wages based on take-home income (given level and scope of public services)- higher redist (to te extent that that is synomomus with higher taxation) will tend to increase their wages.

lower Earners (def; net recipiants) will alter their reservation wage given the benefit profile they face. Depending on the marginal tax rates of work, and out of work benefits, this could raise or lower their incomes.

Either way, the two are contingent, and net of redistribution measures is the more 'real" of the variables as it describes peoples actually observed incomes. Hence should be consider the pre-eminant indicator.

and if the elites are taking home more pre-tax and less post-tax, well then any additional managerial power that they have used to extrat pre-tax rents is clearly not doing them all that much good in the long game.... so, er, yeah...

[Tim Worstall]

Sadly this is a bit of a straw man. I don't argue that pre-tax inequality isn't important. True, I don't argue that it is either. However, I'm making a different point.

If we want to know whether we should do more we have to take account of the effects of what we already do.

If we want to look at the poverty rate then we can indeed look at poverty by market incomes. But if we want to try and decide whether there should be more redistribution to change that poverty rate then we need to look at poverty post taxes and benefits.

My point is nothing at all about the desirability of predistribution, redistribution or the amount of either that we should have. It is only and purely that if we're to look at what we should do we do have to measure the effects of what we're already doing.

[Kmichaelwilson]

So why not advocate the elimination of taxes altogether, precisely in order to work around these psychological biases? Isn't taxation as it stands something of an artifact of the long-irrelevant material constraints of coining money?

I'm continuously puzzled why almost no progressive thinkers, including the MMT crowd, advocate the elimination of per-person taxation and its replacement by government's spending money into the economy as required. The bureaucratic overhead, like in a single-payer health system, would be greatly reduced, and the anti-tax propagandists on the right would be silenced.

[Metatone]

As usual Tim's point is that the only problem with the world is that the rich aren't getting enough of the money...

[Gavin]

That's not really true though tim. If you wish to understand the efficacy of a treatment it would be helpful to look at both the severity of the underlying disease and the patients performance post treatment, not just one.

However there's still a problem as pre-tax income distribution is a poor counterfactual as the pre-tax wages of the rich are inflated due to progressive taxes and those of the poor reduced through income transfers. Depending on the incidence of the taxes and transfers respectively. Which links to Chris's problem about redistribution being insufficient to acheive equality.

[paulc]

@Tim Worstall"My point is nothing at all about the desirability of predistribution, redistribution or the amount of either that we should have. It is only and purely that if we're to look at what we should do we do have to measure the effects of what we're already doing."

That was 'your' point. The 'point' in this article is that in making a big distinction between wealth and incomes 'after tax and benefits' as Worstall does, itself leaves out the far bigger problems posed to society of 'disparities in income 'before taxes and benefits'. Or else if we take the Worstall route, we'll just be [perhaps] deciding on more redistribution when in fact we need to think about 'pre distribution' incomes if we want to deal with underlying issues rather than palliative responses to 'symptoms'.

Perhaps Tim Worstall just wanted to undermine the original article by a Guardianista and wasn't concerned with more substantial issues? Now there's a thought. :)

[thenewcomer]

Ugh- rich-man-worship kills me, and now my kids are doing it too! I hate rich people.

http://thenewcomer.wordpress.com/2009/10/06/i-hate-rich-people/

[fake]

Does anyone have any useful ways of combating these disparities, in a world economy, that are not the ole, tried tested and failed, market controls methods?

[NoniMausa]

This is an easier problem to parse if you set aside dollars and paycheques, and look instead at goods and services and human effort, and who determines their mobilization and remuneration.

At present, if they wanted, banks and business could hire 167 million people at minimum wage, from that $3 trillion they are sitting on. But they don't need 167 million American workers. Instead, they can selectively hire small numbers of Americans for specialized purposes, for short periods of time, tossing them back into the population pool without consequence.

What the unequally wealthy people have is not exactly wealth, but control of other people's effort, with very little responsibility for their well being. The inequality, together with the large percentage of people living with remuneration at or below the cost of living, ensures that control is nearly inescapable.

In an old story, a man worked for most of his life for the city, polishing the brass cannon in front of city hall. Then one day he quit and used his savings to buy a brass cannon, and went into business for himself.

If you laughed, you see the point. In our current economy, most people's labour options amount to the same thing. They can work for "city hall," or they can polish their own cannon, until their savings are exhausted.

Noni

[Sondi]

At last, someone comes up with the "right" awnser!