View: Income Inequality is NOT the Real Problem

This economics viewpoint is contributed by a former economics lecturer, and is inspired by his former economics students XB and ZB

Introduction to the View

This paper argues that, while many economists and journalists argue that income inequality is a problem in the world today, it is not fundamentally a real issue or problem, but the lack of economic growth and issues with social mobility are the larger problem. This paper takes a meandering view around various theories, ideas, and opinions surrounding this challenging and often controversial topic.

Income Inequality

What is income inequality? Income inequality is about the extent to which income is being distributed unevenly among a group of people. Economic inequalities are shown by people’s different economic positions within a distribution, in terms of wages, non-wage income, and wealth, for example. However, people’s economic positions are also related to other characteristics, for example, their level of disability, ethnic background, or gender.

Measurements of Income Inequality

And there are various ways of measuring economic inequality. 

While there is no systematic economic measure, and econometric statistics differ, there are some common measures, for instance, the Gini coefficient, which measures inequality across the whole of society. According to economic theory, if all the income went to one person and everyone else got nothing, the Gini coefficient would be equal to 1 (meaning maximum inequality). On the other hand, if income was shared equally, the Gini coefficient would equal 0 (maximum equality). In other words, the lower the Gini coefficient, the more equal a society, the coefficient itself being between 0 and 1, for those who are interested in mathematics.

And the Gini coefficient can measure inequality before or after tax and before or after housing or other related costs, and, most importantly for our purposes, will vary depending on what is actually being measured.

The Gini coefficient is also related to what is known as the Lorenz curve, another method of measuring income inequality. Basically, a Lorenz curve shows the percentage of income earned by a given percentage of the population. A ‘perfect’ income distribution would be one where each percentage received the same percentage of income. Perfect equality would be, for example, where 60 percent of the population gain 60 percent of national income. The further the Lorenz curve is from the 45 degree line, the less equal is the distribution of income. It might be interesting to know that the Lorenz curve is directly related to the Gini coefficient and the area under the curve can be used in calculations of the coefficient itself.

Issue of Poverty

Another related economic issue that has to be discussed when it comes to discussing income inequality is the issue of poverty.

What is it, really? People in poverty are those who are considerably worse-off than the majority of the population. Their level of economic deprivation means they are unable to access goods and services that most people consider necessary to an acceptable material standard of living, or to borrow an academic term, they lack economic affordances.

Absolute vs Relative Poverty

There are two main types of poverty that we can consider here. Poverty can be absolute, where absolute poverty refers to a level of deprivation that does not change over time, or a relative term in which relative poverty means that the definition fluctuates in line with changes in the general material living standard.

Inequality, by contrast, is always a relative economic term: it refers to the difference between levels of material living standards and/or income, across the whole economic distribution. In practice, poverty and inequality are correlated and often rise and fall together, but this need not always be so. For example, income inequality can be high in a society without high levels of poverty due to a large difference between the top and the middle of the income spectrum, especially in cities that are small and dependent on trade, such as coastal cities.

Technological Disruptions and Income Inequality? 

What causes income disparity? 

There are many reasons. It is my view, and the view of some respectable economists, that fundamentally, technological disruptions are right at the centre of income inequality. For example, some have argued that changing and evolving technology is the primary reason for the increasing income gap in the USA. For several decades after WWII, new technology was a great leveller in the US, providing good jobs for workers. In the 20th century, US income inequality reached its low point in the 1950s, when technological change was rapid and material living standards increased dramatically. But around the 1970s, technology’s economic impact began to change. It went from being an equaliser to a factor that became complementary to people who were highly trained and highly skilled. And, in that transition, less-skilled workers were left behind. This was also the time of globalisation, and in a related vein as we approached the financial crisis, there was massive deregulation, liberalisation, and lowering of corporate and income taxes which favoured the rich, wealthy, and skilled, vis-à-vis the poor, asset-poor, and unskilled workers who could not take advantage of these wonderful economic conditions that were propitious for those who could. (In this link, we discuss the economic impact of disruptive technology on Singapore.) 

Social and Economic Mobility 

Another related issue is one about social (and economic) mobility. In his very controversial tome Capital in the Twenty-First Century, Thomas Piketty noted that Napoleon justified concentrations of wealth and high levels of inequality in France because the nation was a meritocracy. If you worked hard and had talent, you could rise to the top of the metaphorical economic ladder. 

Some people say that such claims about income mobility have been made by the privileged at the top of the economic ladder. In fact, the American dream is similarly built on this central assertion. First used by the US historian James T. Adams in his book The Epic of America in 1931, the American dream is a term to describe the complex beliefs, religious promises, and political and social expectations in the US, and for a lot of people this American dream is connected to becoming wealthy and the ability to achieve everything if one only works hard enough for it. And for yet others, the dream is about liberty (not limited to economic liberty but certainly also making references to it) and the US being the country of unlimited economic opportunities.

What did Piketty say, Anyhow?

As an aside, who is Piketty in the first case, and what are his economic ideas? He has been rather famous for a few years now. 

According to The Economist, Capital in the Twenty-First Century was published in French in 2013 and in English in 2014. The English version became a bestseller, and prompted a debate on global inequality. Some economists even believe it caused a shift in the focus of economic policy toward distributional questions. 

According to Piketty, in the 18th and 19th centuries, western Europe was highly unequal. Private wealth dwarfed national income, concentrated in rich families who sat atop a rigid class structure. Only the chaos of WWI and WWII and the Great Depression in between disrupted this economic pattern of control. High taxes, rising inflation, and the growth of welfare states caused wealth to shrink dramatically, and ushered in a period in which both income and wealth were distributed in egalitarian fashion. (Do note the Eurocentric slant of his analysis and the provenance of his data.)

But the economic and political shocks of the early 20th century faded and wealth is now reasserting itself. On many economic measures, Piketty reckoned that the importance of wealth in modern economies was approaching levels seen before WWI. From this economic history, Piketty derives an economic theory of capital and inequality: other things being equal, faster economic growth will diminish the importance of wealth in a society, whereas slower growth will increase it, and demographic change that slows global economic growth will make capital more dominant. 

But there are no natural economic forces pushing against the steady concentration of wealth. Only a burst of rapid economic growth, for him, either from technological progress or rising population, or government intervention can keep economies from returning to patrimonial capitalism. 

Piketty in fact recommended adopting a global tax on wealth to prevent soaring inequality contributing to economic or political instability. The book has attracted plenty of criticism. Some wonder whether Piketty is right to extrapolate about the future from past data. And economic theory suggests that it should become harder to earn a good return on wealth the more there is of it, because of diminishing marginal returns. Also, today’s rich, such as Gates or Zuckerberg, come by wealth through work rather than inheritance. Piketty’s policy recommendations are likely ideologically than economically driven.

Is There a Problem with the US' Social and Economic Mobility?

But many of the economic sceptics nonetheless have kind words for the book’s contributions. And since the last few years nonetheless, however, the findings of Piketty and other economists have entered mainstream debate, challenging long-held assumptions. From examples in the USA, bringing into focus how lopsided US income distribution is, findings have not only shown that inequality is widespread, they have also demonstrated that there is relatively little opportunity for those in the lower quintiles of earners to move up to a higher bracket.

Economic conservatives have long argued that inequality is fine as long as income mobility is robust. However, economic data gathered since the early 2000s have shown that US social mobility is low and has been so for half a century, and indeed, it is considerably lower than the US’ European competitors, where social safety nets are much larger and taxes much higher.

In response, many economic commentators and journalists have decried the unequal distribution of income and wealth and argued that governments should limit inequality at the top and make it easier for people to climb the economic ladder. There is an economic problem with this, however. Think about it. For every poor kid who rises to the top fifth in income, someone must fall out of the top fifth. And the proportion of those who rose was never robust, even in the nineteenth century. Some go up, and others go down.

What matters more is absolute social mobility: the degree to which the economy can produce rising wages for all. In other words, the American dream should be built on expanding opportunities for society, which can only come about if average real wages go up. Earning more than your parents is as much or even more a result of the rise of wages after inflation across the economy as it is a reflection of income mobility. In other words, if you are born into the bottom quintile but real wages rise, you will likely exceed your parents’ income even if you remain in that quintile.

Possible Solutions

What we now know is that we cannot rely purely on social mobility to solve these economic problems. Because there has been economic growth, about two out of three children these days are doing better than their parents. But many of them are not doing much better, and about half of this group remain in the same quintile they were born into. Indeed, rising income inequality also makes it harder to move from one quintile to another: the rungs on the economic ladder are farther apart.

Redistribution is not a sustainable solution to the whole complicated issue: For two decades, the inequality lobby tended to focus on a tax solution – how the rich can be taxed more and how that tax can be better spent on reducing the gap between rich and poor. It is not a good way to solve the economic problem, although it is definitely a fast way of creating flatter income graphs. 

Social and Economic Policies

And the main point for all of us is that a combination of social policies and economic growth policies are needed to produce wages for all. They could include a higher minimum wage (but not necessarily a Universal Basic Income or universal income), child allowances, and more and higher level educational programmes. 

But they should also include serious economic stimulus measures by governments to promote economic growth. And for example, government spending programmes should aim to sustain decent income levels through unemployment insurance, expanded earned income and child tax credits, and outright cash allowances. The government should also aim at foundational projects that facilitate long-term economic growth, including expansion of transportation and online infrastructure.

Have Faster and More Economic Growth

There is simply no escaping the central fact here that welfare depends on faster economic growth. In fact, there is always some inequality in any vibrant economy. 

The focus should rightly be on the vitality of the overall economy. And to that end, equality of opportunity which gives workers chances to succeed, is the bigger and more important concern that all governments should address. Give more economic chances - but how can the economy create more economic opportunities?

Entrepreneurship

The answer could be entrepreneurship. In a related issue, this whole issue is related to the fact that we need more entrepreneurs in society as a whole. When entrepreneurship drops, job creation drops, dragging economic growth with it. Perhaps, economic innovation, creativity, and the willingness to take risks will reduce and ameliorate income inequality and produce economic growth for all – so perhaps in the final analysis pro-growth entrepreneurship is the real economic answer to income inequality.

JC Economics Essays - We aim to be an economics blog with opinions, views, and perspectives. The article was contributed by S and he worked in conjunction with XB and ZB. The rest of the research came from academic articles. (XB once raised some of these important economic issues at a forum and some of the views are his.) Thank you for reading and cheers. 

Economics Question on the "Fat Tax": “Unhealthy foods should be taxed.” Discuss. [25]

“Unhealthy foods should be taxed.” Discuss. [25]

This paper discusses if a “fat tax” should be imposed. What is a fat tax? Generally, a fat tax is a tax on the producer of unhealthy foods, for instance fast food or fatty food producers, and in particular a fat tax is an indirect tax that aims to reduce the supply of unhealthy food. A fat tax is considered by and levied by the government. This Economics paper argues that a tax on unhealthy food will raise equilibrium prices and lower the equilibrium quantity transacted, and hence will save lives by both saving private individual lives and also by addressing the societal market failure of negative externalities; yet on the other hand, there are certain other economic and non-economic perspectives that governments should also consider before implementing such a tax.

Arguments for a Tax on Unhealthy Foods: Personal Cost of Obesity – A Fat Tax Saves Lives

First and foremost, eating unhealthy foods increases the likelihood of obesity, early death, depression and a whole range of health problems. A fat tax will raise the price of such foods. Higher prices caused by such a tax would discourage people from consuming unhealthy foods. It may not stop people eating fatty foods completely, but this is not the primary aim. Reducing consumption of fatty and salty foods would have a significant benefit in improving health and personal wellbeing. Currently, many people from all around the world die from heart attacks and strokes each year. As well as saving lives, reducing obesity will also improve consumers’ quality of life. According to the diagram below, a tax will shift the supply curve to the left, and thus raise the price of the good and lower the quantity transacted. This translates into less unhealthy foods consumed.

Arguments for a Tax on Unhealthy Foods: Externalities of Unhealthy Foods

Unhealthy eating has an impact, not just on consumers, but also on the rest of society. An externality is a third party spill-over effect, and can be classified as negative or positive. Fatty foods, by harming consumers, have massive external costs to society and as such produce negative externalities. For instance, there are medical costs for treating obesity, and worse still these explicit costs also come with opportunity cost, the cost of the next best alternative forgone, which means that other patients could potentially receive less attention and other more pressing diseases receive less funding. Also, there would be lost productivity at work not just due to obesity but also to illness, premature death, and a whole host of health-related problems that affect society negatively and have to be paid for. Therefore, the government should collect sufficient taxes from the producers of unhealthy foods to pay for the external costs that they create. It is the same principle as to why cigarettes are taxed, because cigarettes cause pollution, and harm or kill consumers and third parties alike.

While it can be argued that the external cost of unhealthy foods is not easy to calculate, due to imperfect information, this is not a reason to avoid having a fat tax. The idea is that at the moment society is effectively subsidising the consumption of unhealthy foods, and ultimately it is the taxpayer who has to pay for this in terms of healthcare, workplace, and productivity costs to society.

Arguments against a Fat Tax: A Tax on the Poor

On the other hand, a fax tax could be seen as politically unacceptable, because it could be perceived as just another scheme to raise government revenue. Thus, a tax on unhealthy foods should be revenue neutral and not about raising total tax revenue, but about switching the tax burden. The revenue raised from the fat tax could be used to subsidise healthy foods, pay for healthcare services, or reduce other types of taxes.

Also, a fat tax can be seen as a tax against the poor, who tend to eat fast food or are unable to afford more expensive healthier food. The argument is that those on low incomes are more likely to consume unhealthy foods and therefore this tax will increase inequality as it targets the poor. However, it can be argued that if a tax on fatty foods saves lives, we should not avoid implementing it because, in fact, it is the poor who will mostly benefit because their lives will be saved. If the government is concerned about the impact of a fat tax on equality, the revenue can be targeted to the poor by redistribution, for example by transfer payments. Thus, an increase in inequality need not occur from a fat tax.

Arguments against a Fat Tax: Paternalism

Some people argue that a fat tax smacks of paternalism (what is sometimes known as the “nanny state”). Who is the government to tell people what to eat? It would seem that on the surface the government is telling people what to do. However, the whole point is that consumers are still free to consume as much salty and fatty foods as they like. It is just that now consumers have to pay a fairer reflection of the true cost to society, which means that they have to internalise the negative externality, the negative harm to society which results from their health problems caused by such foods. Thus, society has a right to make consumers pay for the economic cost of unhealthy food. Also due to imperfect information, consumers may not know the full damage done by unhealthy food. Hence, paternalism might actually be good for them. As an additional benefit, consumers will probably live longer, and healthier, and also feel happier.

Arguments against a Fat Tax: Inelastic Demand

Some detractors could argue that the demand for fatty foods could be inelastic, and as such a tax would not reduce the quantity demanded by a lot. This is because, ceteris paribus, a relatively inelastic demand curve means that a huge increase in price would lead to a small fall in quantity demanded. However, while demand may be inelastic for fatty foods, they will still reduce consumption by a certain amount, and this is the intended effect. For example, a huge tax on a fast food meal may reduce consumption by say 30%. Instead of eating ten burgers a week, some consumers may only consume seven burgers a week after the tax is imposed. This reduction of 30% will have a big impact on improving the consumers’ health. The aim is not to stop consumers eating unhealthy foods, but reduce excessive consumption, because in moderation fatty and salty foods do not cause a fundamental health problem.

Conclusion

In conclusion, a fat tax should be imposed to save individual lives, and, above all, to reduce the massive negative externalities of illness and lowered productivity imposed upon society. The fat tax will force consumers to internalise the negative externalities whilst allowing them to enjoy, in moderation, fast food, and therefore in the final analysis unhealthy foods should indeed be taxed. 

JC Economics Essays: Tutor's Comments - This Economics paper is about an interesting and current topic that many countries worldwide have discussed: should they implement a fat tax, or a tax on unhealthy foods? How should this fat tax be implemented? This essay makes interesting and easy reading, and covers a lot about inequality and other related issues, that you should definitely study and write about during an Economics examination on this topic of the fat tax. However, my usual tutor's comment applies: other than a diagram or two, how would you make this paper better? What would you write differently here? What other Economics materials and points could you add in to make this Economics paper better? Remember to give it a good, critical viewpoint as well. As an Economics tutor, one major improvement would be that the conclusion could be a little bit more evaluative and considered - which means that the student should have an opinion (or two) and a justification that weighs up arguments, and is nuanced, balanced, and perhaps even "personalised". Thanks for reading, and do give this serious thought!