Why should we care about income distribution?
Should we bother about income distribution? The Negative Income Tax, that you have just learned, has the advantage of income redistribution which, as you have seen in your indifference curve diagrams, is superior to any kind of in-kind transfers. Yet the basic questions about income inequality should be debated. These are some of my thoughts.
From a Christian perspective, this is what I have to say: The last of the Ten Commandments of the Old Testament stated, "Do not covet your neighbour's wife...or anything that belongs to your neighbour." That seems to imply that the poor should not be envious over the rich nor worry over income inequality. In my opinion, the poor need not worry because God's idea of income redistribution seems to be similar to the classic "lump-sum" cash transfer in economics, given by Exodus 16:17-18: "The Israelites did as they were told; some gathered much, some little...he who gathered much did not have too much, and he who gathered little did not have too little." It is like the rich realizing, all of the sudden, that money has been taken away from them and given to the poor. As you have seen through the indifference curves, this lump sum tax of the rich will not distort their behaviour and the lump sum subsidy to the poor will similarly result in zero welfare cost to society. It is amazing how God knows so much about economics :-). For those who do not have to faith to wait, let us examine the economic viewpoint about income distribution.
David Ricardo (1772-1823) was the first known economist to focus mainly on issues of income distribution. The opening preface of his book, On The Principles of Political Economy and Taxation, states:
"The produce of the earth - all that is derived from its surface by the united application of labour, machinery, and capital, is divided among three classes of the community; namely, the proprietor of the land, the owner of the stock or capital necessary for its cultivation, and the labourers by whose industry it is cultivated...To determine the laws which regulate this distribution, is the principal problem in Political Economy"
Ricardo analyzed income distribution in terms of workers, capitalists and landlords. At this present era, we no longer have such a dichotomy. Instead, we tend to view income distribution in terms of classes, namely the upper class, the middle class as well as the lower class. Thus, proponents of income equality would say that we "should" redistribute income from the upper class to the lower class.
Now, I begin to think, "What is wrong with income inequality?" The neoclassical viewpoint towards income distribution is simply this, all of us are paid according to the value of our marginal product, given by the familiar equation:
Price*Marginal ProductLabour = Nominal Wage
Since there are always people with different productivities in any given society, it makes no sense for any government attempting to redistribute income. If the government were to do that, it will distort economic behaviour, leading to welfare costs. The counter-argument might be that some people are of lower productivity through no fault of theirs, such as those who dropped out of school to support their families for example.
Indeed this is the main problem of capitalism. Its view on income distribution is only justified on the assumption that all of us begin with the same initial endowments. But I thought of an interesting side issue regarding initial endowments, "why are we so concerned about the income gap while there are other kind of inequalities, for example, the beauty gap, that nobody seems to bother as much?" I recall the Straits Times, Life section, running an article some years back about girls who go for plastic surgery to enhance their looks. One of the girls, who was interviewed about her reasons, said that she receive much more help and attention from guys as well as more opportunities to show what she is really capable of, thus she has no regrets going for the operation. Her dad even approved of her decision. I believe that, in our current society, it is undeniable that looks matters to ladies, not just in terms of psychological reasons, but in economic opportunities too. Yet, we do not seem to hear many people complaining about this 'beauty inequality' nor insist that we attempt to close this gap. Why are we more fussy over money than other things? That is something I would like to think about from now on.
Today, the question over income distribution seems to be represented as a trade-off between efficiency and equity: "Should we worry more about increasing the size of the economic pie instead of worrying over who gets the various slices and of what proportion?" Singapore is currently encouraging 'foreign talents' to come to Singapore to work. The official viewpoint is that although they may initially displace some Singaporeans, eventually, they will create more jobs for everyone. The main justification behind the increasing the size of the economic pie first before worrying about the distribution, similar to the second theorem of welfare economics, is based on Samuelson's 'potential compensation principle' in The Economic Journal, Vol. 72, No. 288. (Dec., 1962), pp. 820-829.
Finally, there is an interesting article by Paul Krugman about his own views towards income inequality. In summary, Krugman is saying that, what is more important to us is not how rich we are in absolute terms but how rich we feel relative to our Joneses neighbours. I think that is certainly very true.