TOPICS > Economy

Does U.S. Economic Inequality Have a Good Side?

October 26, 2011 at 12:00 AM EDT
A new Congressional Budget Office analysis supports the idea that income inequality has grown considerably over the past few decades. As part of his Making Sen$e series on economic inequality, Paul Solman talks to libertarian law professor Richard Epstein, who argues that wealth inequality acts as a driving force for innovation.
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JEFFREY BROWN: Now to our own continuing series on inequality.

A new analysis from the Congressional Budget Office supports the idea that income inequality has grown considerably over the past few decades. The report found that household income grew by 275 percent between 1979 and 2007 for the wealthiest 1 percent of the population. For the rest of the top fifth of the country, it grew by 65 percent. By contrast, the bottom fifth of the population saw its income grow by just 18 percent.

The NewsHour’s economics correspondent, Paul Solman, has been exploring the consequences of those trends in previous stories he has done in his series. Tonight, he gets a contrarian view, suggesting inequality in a free market system may not be as bad as advertised.

It’s part of his ongoing reporting on Making Sense of financial news.

PAUL SOLMAN: Richard Epstein, welcome.

RICHARD EPSTEIN, New York University School of Law: Thank you for having me.

PAUL SOLMAN: What’s good about inequality?

RICHARD EPSTEIN: What’s good about inequality is if, in fact, it turns out that inequality creates an incentive for people to produce and to create wealth, it’s a wonderful force for innovation. So let’s just go and take somebody like Bill Gates again or any entrepreneur.

Guy earns $50 billion, right? How much consumer welfare has he created by selling products? We can estimate the amount of gains to purchases, because everybody who buys one of his products or one of Steve Jobs’ products, in effect, values it more than he receives.

The social gain from inequality to consumers of those goods probably dwarfs the entrepreneurial gain by a factor of 10-1 or 20-1.

PAUL SOLMAN: So you mean the incentive for great wealth had Steve Jobs and Bill Gates create products which created so much value that it far outstripped the compensation to them?

RICHARD EPSTEIN: Yes.

And one of the fundamental mistakes about the egalitarians is they’re so interested in trying to minimize differences that they don’t understand the completely adverse effects that it has on the size of the pie.

PAUL SOLMAN: Epstein worries about attempts to raise marginal tax rates, that is, the higher percentages paid on higher amounts of income.

RICHARD EPSTEIN: You can tell the difference between a liberal and conservative by the following test. A liberal believes that changes in taxes have very little effect on production, but huge effects favorable on distribution.

Folks like myself believe it’s exactly the opposite. Very high tax rates or even small changes in taxes have very adverse effects on production, and they do very little to produce redistribution, because the money gets dissipated and taken away through the political process in the ways that even the most ardent supporters of redistribution will not like.

PAUL SOLMAN: You think that Steve Jobs and Bill Gates wouldn’t have done what they had done with higher marginal tax rates?

RICHARD EPSTEIN: Well, yes, because they just don’t do it. They have to be able to get investors to sign up for their things. Those investors have to have disposable income.

You start changing the particular policies so that there is high or marginal rates on taxable income, two things happen simultaneously. People have less money to invest, and people will be less willing to invest it because they will get a lower rate of return.

PAUL SOLMAN: In the period in which the American economy grew most vigorously, the United States had higher marginal rates, much higher, higher capital gains rate, and more prosperity and greater economic equality.

RICHARD EPSTEIN: No.

First of all, the highest marginal tax rates were also accompanied with tax shelters for everybody in those rates. The second thing is that the monies that were being spent in those days were being spent in much more intelligent ways. That is, if you go and you look at either state or federal budgets and see the amount of money that is spent on what we would call standard infrastructure improvements, and spent well, like the interstate highway program in 1956, that was very high.

The money that is spent today on infrastructure improvements of a good variety is a tiny fraction of what it was then. And the amount of money that is spent essentially on transfer payments has mushroomed enormously.

The fundamental truth is, the tax system is more redistributive than it was before, which will lead to a reduction in efforts, and the regulatory burden on the economy is vastly greater, and we would expect lower levels of growth.

PAUL SOLMAN: So, if inequality is good because it provides incentives to people, is equality bad because it provides disincentives?

RICHARD EPSTEIN: No, it’s not the equality or the inequality. It’s the possibility of earning a high rate of return which does it.

And what happens is, if you let people go through voluntary transactions that produce mutual gain, you will increase overall welfare, you will improve the position of those on the bottom. But increased overall welfare will produce greater skews in income, because in a world with genuine opportunities, you will create billionaires.

In a world without it, the people at the bottom will remain where they were, there will be nobody at the top to subsidize them, so everybody will turn out to be worse off.

PAUL SOLMAN: Aren’t many of the top 1 percent or 0.1 percent in this country rich because they’re in finance?

RICHARD EPSTEIN: Yes. Many of the very richest people in the United States are rich because they are in finance.

And one of the things you have to ask is, why is anyone prepared to pay them huge sums of money if in fact they perform nothing of social value? And the answer is that when you try to knock out the financiers, what you do is you destroy the liquidity of capital markets. And when you destroy the liquidity of those markets, you make it impossible for businesses to invest, you make it impossible for people to buy home mortgages and so forth, and all sorts of other breakdowns.

So they should be rich. It doesn’t bother me.

PAUL SOLMAN: Are you worried that a small number of people controlling a disproportionate share of the wealth can control a democratic system?

RICHARD EPSTEIN: Oh, my God no.

If you think the rich are controlling the situation, why is it that anything more than $1 million on a home mortgage turns out to be non-deductible, while the amounts that are below that are left? If one thinks that the rich dominate the particular system, why is it Obama is targeting for political advantage people with incomes over $250,000, rather than those who are under that particular figure?

You’re talking about 1 percent of the people, and they’re going to win an electoral battle against the multitudes? Forget it. It’s just not going to happen.

PAUL SOLMAN: You mean to tell me that you don’t think the top 1 percent of Americans don’t have a disproportionate impact on the political process?

RICHARD EPSTEIN: No, of course they have a disproportionate impact, but that doesn’t mean that they control it. They also ought to have it.

The last thing you would want to do in any kind of sensible society is to have a set of rules in which one man/one vote dictates over every issue. And the last thing we need is a popular democracy in which one man/one vote and which you can have select taxes on people, because once you can have selected taxes on certain people, why not go along and say, you know, this is a wonderful mansion that Mr. Gates owns, what we ought to do is just take it and sell it off to some foreign sheik, and take the money and divide it amongst ourselves?

PAUL SOLMAN: Are you in favor of an inheritance tax?

RICHARD EPSTEIN: I’m in favor of its abolition. I have said that for years. I think the estate tax is the most mad tax imaginable.

PAUL SOLMAN: But if the point of inequality is to provide economic incentives to productivity, then why shouldn’t everybody start from scratch?

RICHARD EPSTEIN: Because that’s a crazy — I mean, starting everybody from scratch turns out to be exactly the worst way to do this thing, because it means that no parent is now going to be entitled to make investments in human capital, in their children.

That means you’re going to try to socialize all the wealth. And once you try to do that, what will happen is that the level of excellence that you will get at the top, which is where you generate most of your future wealth, will be necessarily compromised.

PAUL SOLMAN: Wait. But if you think that transfer payments to poorer people disincentivizes them, why wouldn’t transfer payments that you and I would make to our children disincentivize them?

RICHARD EPSTEIN: Because I can take care of my own money and deal with my own family in a prudential and rational way, knowing this incentive, knowing who my children are.

I give it to the United States government, they just give it out at random. The chances are that it will be watched and flourished is completely different.

PAUL SOLMAN: I assume you have some sympathy for people who are increasingly falling behind?

RICHARD EPSTEIN: Everybody does. The question is, you will not be able to help them through transfer payments. The only way you could help them is through increased opportunities. The rules that people put into place to protect workers strangle them.

PAUL SOLMAN: You don’t think there’s any change over the last bunch of decades in the United States, in the ethos that we all share as to what’s fair?

RICHARD EPSTEIN: No, I think there is a change, I think.

But it runs both ways. Most Americans like both things. They like to have opportunities for themselves and they like to have guaranteed incomes for themselves. And it turns out that one of the things that is so sad today about the American ethos is that people are much more talking about the me generation or themselves, instead of trying to think about this thing as a more systematic and global issue.

And if you start to think about that — I’m going to quote Abraham Lincoln, because I like to do that — which is, he said, quite rightly, that you do not make the poor rich by making the rich poor.

PAUL SOLMAN: Richard Epstein, thank you very much.

RICHARD EPSTEIN: It’s been a great pleasure to be here.

JEFFREY BROWN: That was libertarian law professor Richard Epstein. He teaches at New York University School of Law.