The cost of redistributing wealth

The cost of redistributing wealth
Should we just redistribute all the wealth until everyone has an equal amount?

’d like to explain how most modern economists think about wealth redistribution. If you discuss welfare, taxes or inequality with an economist, you are bound to run into a concept called the equity-efficiency tradeoff. It’s the idea that there’s a fundamental tradeoff between the size of the economic pie and the equal distribution of said pie.

Suppose you’re a really rich person. You have $50 billion in wealth, though it fluctuates day to day depending on the financial markets. But even if the markets take a tumble, you will still have enough to buy almost anything you want.

Now suppose some hacker comes and steals $10,000 out of one of your brokerage accounts. The difference it would make in your purchasing power would be negligible. Now suppose that hacker, in the tradition of Robin Hood, decided to give the stolen $10,000 to a poor man in a slum in Baltimore. That $10,000 is probably as much as the poor guy earns in a year. Suddenly, his yearly salary is doubled and his risk of having to sleep in a homeless shelter is dramatically reduced.

This difference in the marginal value of wealth—the value of each additional dollar—is a key part of modern economics. It underlies our theory of risk and our theories of labour and leisure. But it also has implications for what we think of as human welfare—the total well-being of the species, or the nation. A given number of dollars creates more well-being in the hands of the poor than in the hands of the rich.

So, should we just redistribute all the wealth until everyone has an equal amount? Even if you think that doing so would be morally acceptable, you would have good reason for caution. Although rich people might not notice one or two random thefts from their bank accounts, they will most definitely notice the systematic appropriation of their wealth by the government. That systematic appropriation, of course, is called taxation.

When you tax people, you usually cause them to reduce the amount that they do the thing that is subject to the tax. That’s not always true—if you tax people’s labour, they may work less because of the decreased value of an hour of work, or they may work more because they are poorer than they were before. But in general, taxation reduces economic activity. Taxing investment reduces investment, and taxing consumption reduces consumption.

Anyway, the basic message is that the more the government tries to shift income around, the less total income there is to distribute.

This is sometimes known colloquially as “Okun’s bucket”, after economist Arthur Okun, who once likened redistribution to moving wealth from one person to another with a leaky bucket.

Modern empirical techniques have allowed economists to get a better idea of how big the leaks are in the bucket. For example, a recent paper by Nathaniel Hendren looks at the earned income tax credit, food stamps and housing vouchers. He finds that for every dollar redistributed from rich to poor with those programmes, anywhere from 34 cents to 56 cents leaks out and is lost.

This is how economists think when they consider redistribution programmes like the ones mentioned above. They don’t normally consider moral questions, like whether it’s ethical for the government to confiscate one person’s income in order to give it to another. When they do attempt to wade into the moral side of things, the result is often ham-handed and awkward.

Thus, economists typically leave questions of justice to the philosophers and politicians. Mostly, they focus on trying to quantify the tradeoff between equality and efficiency. That may seem a bit heartless, but to many economists, it feels like the most objective way to approach questions of redistribution. Bloomberg