Ask America’s rich people, and they will agree: Incentives for production are what matter for economic prosperity. What makes the economy go is the ability of people to capture the income streams from their efforts to produce things. (The fact that the next step in the argument is usually something like “so we must cut the capital gains tax!” and vastly enrich the already wealthy is, I’m sure, a total coincidence.)
But there is another side to the argument that tends to go unmentioned in these discussions: incentives for consumption. What good is production, after all, if few people can buy your products? If that’s the bottleneck that is holding back the economy, then trying to increase or streamline incentives for production won’t get us very far. Therefore, economic progressives need not worry too much about the effects of anti-inequality policy.
Larry Summers, in an otherwise pretty good column today, rather muddies this issue:
If total income were independent of efforts at redistribution, there would be a compelling case for reducing incomes at the top and transferring the proceeds to those in the middle and at the bottom. Unfortunately, this is not the case. It is easy to conceive of policies that would have reduced the earning power of a Bill Gates or a Mark Zuckerberg by making it more difficult to start, grow and globalize businesses. But it is much harder to see how such policies would raise the incomes of the remaining 99.9 percent of the population, and such policies would surely hurt them as consumers.
So surely it would be possible to reduce income inequality in such a way as to shrink total income. If we go to paranoid billionaire fantasyland, where progressives argue that what we should do is round up rich people and systematically murder them, that probably wouldn’t help economic growth or the masses at all.
But in the real world, realistic solutions to inequality involve changing the distribution of resources. We could raise taxes on the rich and distribute the proceeds downward, by beefing up food stamps and the earned income tax credit, or something similar. Even raising taxes isn’t necessary — we could also just borrow money for some fiscal stimulus. We could even simply print money and hand it out.
And that gets to the nub of the disagreement here. Folks like Summers tend to argue that the only kind of acceptable inequality reduction policy is one that would get rid of “distortions” in the economy — meaning policies like tax reform, which would get rid of loopholes and smooth out incentives.
But in my view, the American economy is and always has been a kludgey hodgepodge, simultaneously overregulated (urban real estate) and underregulated (carbon dioxide pollution) that is light years from an “ideal” incentive structure, yet somehow worked well for decades regardless. The major problem I see today is that millions of people are unemployed and median wages are flat. Growing industries are very often either in ad-supported free networks (Twitter) or wretched luxury products.
Which side is right? Fortunately, it will be easy to determine. We can design some policies to direct money at the bottom 80 percent or so of the income ladder, and see what happens.