"Inequality" is a term that has been tossed about quite a bit. The Occupy movement, to Piketty's book, to debates over the minimum wage, to Greg Mankiw's defense of the 1%. Just today Mark Thoma published an op-ed on inequality. A few days ago John Cochrane had a post about why we care about inequality.

One of Cochrane's main points is that the term "inequality" has been used in so many contexts, and to refer to so many different things, that it is ceasing to lose meaning. I'll agree with him on this completely. If you want to talk about "inequality", you have to be very clear about what precisely you mean.

There are three things that people generally mean by "inequality":

  1. The 1% versus the 99%. That is, the difference in average annual income of the top 1% of all households versus the average annual income of the bottom 99%.
  2. The stagnation of median real wages and those below the median.
  3. The college premium, or the gap in earnings between those who finished college and those who did not (or did not attend).

When I say I care about inequality, I mean mainly the second - the stagnation of median wages - but this is going to take me into territory covered by the first - the growth in top 1% income. There are things to say about the college premium, but I'm not going to say them here.

Why do I care about the stagnation of median wages?

  • Because I'm going to be better off if everyone shares in prosperity. I want services like education, health care, and home repairs to be readily available and cheap. The way to achieve that is to invest in developing a large pool of skilled workers - teachers, nurses, electricians, carpenters. Those at the bottom of the distribution don't have sufficient income to make those investments privately, so that requires public provision of those investments (i.e. schools) or transfers to support private investments. You want to have an argument about whether public provision or transfers are more efficient? Okay. But the fact that there is an argument on implementation doesn't change the fact that stagnant wages are a barrier to these investments right now.
  • Because people at the bottom of the income distribution aren't going to disappear. We can invest in these people, or we can blow our money trying to shield ourselves from them with prisons, police officers, and just enough income support to keep them from literally starving. I vote for investment.

One response to this is that I don't care about inequality per se, I care about certain structural issues in labor markets, education, and law enforcement. So why don't we address those fundamental structural issues, rather than waving our hands around about inequality, which is meaningless? Because these strutural issues are a problem of under-investment. The current allocation of income/wealth across the population is not organically producing enough of this investment, so that allocation is a problem. In short, if you care about these structural issues, you cannot escape talking about the distribution of income/wealth. In particular, you have to talk about another kind of inequality, the 1%/99% kind.

Let me be very clear about this too, because I don't want anyone to think I'm trying to be clever and hide something. I would take some of the income and/or wealth from people with lots of it, and then (a) give some of that to currently poor people so they can afford to make private investments and (b) use the rest to invest in public good provision like education, infrastructure, and health care.

Would I use a pitchfork and torches to do this? No. Would I institute "confiscatory taxation" on rich people? No, that's a meaningless term that Cochrane and others use to suggest that somehow rich people are going to be persecuted for being rich. I am talking about raising marginal income tax rates and estate tax rates back to the archaic levels seen in the 1990s.

Why do I not feel bad about taxing rich people further?

  • Because rich people spend their money on useless stuff. Not far from where I live, there is a new house going up. It will be over 10,000 square feet when it is complete. 2,500 of those square feet will be a closet that has two separate floors, one for regular clothes and one for formal wear. If that is what you are spending your money on, then yes, I believe raising your taxes to fund education, infrastructure, and health spending is a net gain for society.

    Don't poor people spend money on stupid stuff? Of course they do. Isn't the government an inefficient provider of some of these goods, like education? Maybe. But even if both those things are true, public investment and/or transfers to poor people will result in some net investment that I'm not currently getting from the mega-closet family. I'm happy to talk about alternative institutional settings that would ensure a greater proportion of the funds get spent on actual investments.

  • Because I'm not afraid that some embattled, industrious core of "makers" will decide to "go Galt" and drop out of society, leaving the rest of us poor schleps to fend for ourselves. Oh, however will we figure out how to feed ourselves without hedge fund managers around to guide us?

    This is actually a potential feature of higher marginal tax rates, by the way, not a bug. You're telling me that a top tax rate at 45% will convince a number of wealthy self-righteous blowhards (*cough* Tom Perkins *cough*) to flee the country? Great. Tell me where they live, I'll help them pack. And even if these self-proclaimed "makers" do stop working, the economy is going to be just fine. How do I know? Imagine that the entire top 1% of the earnings distribution left the country, took all of their money with them, and isolated themselves on some Pacific island. Who's going to starve first, them or the remaining 300-odd million of us left here? The income and wealth of the top 1% have value only because there is an economy of another 300-odd million people out there willing to provide services and make goods in exchange for some of that income and wealth.

So, yes, I care about 1%/99% inequality itself, because I cannot count on the 1% to privately make good investment decisions regarding the human capital of the bottom 99%. And the lack of investment in the human capital of the bottom part of the income distribution is a colossal waste of resources.