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Wednesday, September 13, 2006


Attacking inequality - By Cliff Brown

In the September 4 edition of the Washington Post, there was an article, written by Sebastian Mallaby, that talks about the inequality gap in the US.

Mallaby briefly discusses three possible options for fixing this inequality, Trade Protection, Unionization and Raising the minimum wage.
Although he does disagree with these options, I will still evaluate them vis-à-vis economics, and analyze his analysis and explanations. He then suggests a method for attacking the inequality that he sees as a political solution; again, I shall evaluate this.

1. Trade Protection.

Anyone who has taken Econ 101, and I suspect that you all have! Should appreciate the implications of forming barriers to trade. The article suggests that trade protection may help those in the manufacturing sector by shielding them from competition. Whilst on the surface that may be true, the effect that trade barriers would have on the entire economy would be a bad thing. The snowball effect springs to mind. Other countries would erect similar barriers and/or quotas. Our net exports would decrease, GDP would fall and the country would fall into a recession. Many that work in the manufacturing sector (along with many of the other sectors) would lose their jobs because Joe public would have no funds with which to consume. It is unlikely that those at the top of the food chain would be seriously affected by this recession, indeed some would prosper, and the inequality gap would deepen. As Mallaby suggests clearly not the way to proceed.

2. Unionization.

Here Mallaby actually promotes unionization. He says that it is needed now because “over the past half decade productivity has shot up while real wages have stagnated.” I am assuming here that by stagnating he means that they have kept relatively close to the rate of inflation, whilst productivity has skyrocketed. So perhaps the solution he is arguing, in favor of the unions, is that they will increase salaries higher than the rate of inflation. Perhaps the reason the salaries are where they are is because that is the salary that the market has determined is the correct amount, and this is the point that Mallaby concedes.
However, how about explaining the growth in productivity by attributing it to improved efficiency and/or better machinery and technological advancements. (Mallaby briefly touches on this last point) Aren’t these the characteristics of our society that we should be encouraging and nurturing? In addition, along the same lines, if we are NOT doing these tasks efficiently then is it not correct far these jobs to be outsourced?

3. Raising the minimum wage.

“Raising the minimum wage will create fewer jobs and/or deteriorate working conditions … and will benefit fewer than 6 million workers”. These are Mallaby’s arguments against raising the minimum wage, and I certainly will not disagree with them. However, I will add that perhaps a bigger reason against an increase is that economically it is not justified. How many minimum wage workers produce work that the market would command a pay of $7.25 an hour for? How many employers would pay $7.25/hour to achieve $4/hour of output? Clearly the MC exceeds MB. Possibly politically this would be good as at that wage perhaps many more “Americans” would do the jobs that only the “immigrants” do now? But economically it does not make sense – And yet Mayor Daley suggested a raise in minimum wage as a solution in Chicago instead of the “Big Box Ordinance” that he recently vetoed. (I would contend that he was half right).

Mr. Mallaby suggests that the correct solution to this inequality is through tax reform, “By eliminating just ¼ of the subsidies in the tax code would liberate $180 billion a year”
So my first question, even if this figure is correct, is where do we liberate it from? The rich, who keep it in financial institutions who then loan out the money, which is used to improve the “Wealth of Nations” and make life better for ALL. Significantly reduce the investment flow and won’t the poor get poorer?

Mr. Mallaby cites three examples of how the tax-code may be amended. First is the mortgage-interest relief policy. He explains that in countries that don’t have such a policy home ownership rate is no different than it is here. I lived in one of these countries, the UK , until I was 23 and you have to compare apples to apples. There is MUCH that is different between the two countries – salaries, income tax rates, VAT, beer, the list goes on, and so to use that as an explanation is a false analogy. Moreover, perhaps the incentive is lost on 50% of home purchasers (they can afford to pay the tax regardless), but what about the other 50%. Doesn’t a policy that helps half of homeowners acquire their property deserve some credit?

Secondly, he talks about the tax incentives that promote savings as being regressive, and only mainly utilized by the top echelons. Again, I would argue that this invested money could now be loaned out which helps us all. What’s the alternative. No incentive, or only those earning less than $X can gain an incentive.

Finally, he argues about tax incentives to buy health insurance. “The treasury estimates that the uninsured could be reduced by 1 million if tax deduction for health insurance were capped at a reasonable level” How many in the US don’t have health insurance? I don’t know the figure, but I would suspect that 1 million is less than 1/20 of the amount. Is the cost to such a policy greater than the benefit to such a small percentage?

Perhaps the more fundamental question here should be what is wrong with inequality? Ask the average Russian citizen that grew up during the good old times of the Soviet Union what they think about equality. It is likely that they will say no to equality, but yes to a system that promotes greater equity – perhaps by better welfare programs, training and equal opportunities.

Maybe these results could be better acheived witout any government intervention at all. The reason for government intervention in the first place would be because of a market failure. Since It is possible that the system as it stands today does not equal efficiency, (remember fairness is not the same as efficiency - positive vs normative) perhaps if we left the market to its own devices things would be better. The market may not also reach an efficiency point, but if the pendulum is swinging in the right direction and is closer to efficiency than when the government intervenes, then the government should be a mute point.

I like your post, but have to also suggest that it could have been improved if written after we had discussed the economics of taxation. Let me make a couple of suggestions based upon what we have studied so far.

First, with respect to the unionization suggestion, I think you might have asked: "But, is there are market failure in the labor market?" Now consider that a union is a monopoly. This suggestion then amounts to support for the policy of creating a market failure. This is the question then I would leave you with: Is there a source of market failure in the labor market for which the economic answer is to create a monopoly market failure?

Second, you could ask the same sorts of questions with respect to the proposal of increasing the minimum wage. Is there a source of market failure in the labor market for which the economic policy answer would be to impose a price floor on the market?

Third, and turning to taxation, each of the deductions the author points to involve the income tax. One might want to ask why so few people in the lower income ranges make use of these deductions? I suggest a possible answer is that between 40% - 50% of the households don't pay income tax. We can check on this later in the semester.

Fourth, we will consider income tax deductions later in the semester, and I think the story will be that from the economic perspective it is better to make the income tax base as broad as possible, and deductions make the income tax base smaller.

Finally, we will spend some time in class discussing inequality in the United States. It turns out that the measures of inequality the author relies on are aggregate measures, and thus these measures hide a great deal. Once we consider inequality by noting the nature of these aggregate measures, we will probably get a much different picture of inequality in the United States
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