Who Gets What
When you tax effort, you get less of it; when you subsidize leisure, you get more of it. Arguments over who is to get the fruits of our labor become moot if the result is less labor and less fruit.
Most of us aren't paid nearly enough, while the other fellow invariably gets too much. Or so goes the folklore. Yet there seems to be an implicit understanding that, within the competitive sector, people tend to be paid according to the market value of what they produce. Consumers ultimately pay all wages and salaries, distributing affluence and poverty by the way they choose to spend their own incomes.
Since consumers often prefer to do business with those who have native intelligence or beauty, the result may seem rather unfair to some—just as the distribution of husbands and wives seems unfair to those who aren't chosen. But, contrary to a now-fashionable belief, distribution of income by political means does not promise fairer results. The same people whose choices in the marketplace might be deplored are not likely to become more enlightened in the voting booth, and the market offers a wider range of choices than the periodic selection between two mislabeled political packages.
Ordinary people—those outside of Cambridge, Massachusetts—rarely resent high incomes that are the result of competitive market forces. The rock star who sells millions of records and thus receives millions of dollars may inspire envy but is generally regarded as having earned his income. Instead, the main targets for resentment are those whose incomes are, to varying degrees, extracted from unwilling consumers through taxes or government grants of monopoly privilege: the bureaucrat, the striking "civil servants," the employee of a regulated cartel, the licensed craftsman—these are the people who are commonly viewed as having an unfair advantage over the rest, an advantage that invariably derives from political clout. We are increasingly involved in a system of mutual plunder. Enormous energies are unproductively employed in attempting either to manipulate governmental policies to extract wealth from others without offering anything in return or to avoid being the target of such political banditry.
People recognize exploitation when it comes their way, and they quite naturally resent it. "Exploitation," in 20th-century intellectual parlance, points a damning finger at capitalists extracting profits by underpaying workers. But it is virtually impossible for employers to exploit workers, since they can and do change jobs if underpaid. What is possible is for workers to extract incomes from consumers, to exploit consumers, by enlisting the government's help in monopolizing some labor skill or the related product or service.
Since all wages and salaries are paid by consumers, competition for the consumer's dollar normally puts an effective lid on wages and salaries. If an employer pays lavish salaries, he will not survive against rivals who are more careful to minimize their costs and can therefore offer consumers a better deal. If all the employers in an industry pay lavish salaries, then the resulting high price of the product will encourage the production and consumption of substitutes. Either way, market forces impose a discipline or budget on salary increases in the private sector.
In the political sector, by contrast, some employees can directly enlist the strong arm of the tax collector. While consumers can refuse to buy, say, automobiles or grapes if wages and prices in those industries get too high, consumers cannot easily refuse to pay taxes. Examples of such direct raids on the public purse can be found in several large cities, where the municipal unions periodically hold the communities up for ransom—which is only possible because of their monopoly over vital services. Obvious remedies include decentralization, returning some of these functions to the private competitive sector, and contracting for services with competing suppliers. Taxpayers "voting with their feet" also provides some competitive constraint against such exploitation. (Federal grants to "ailing cities"—generally those which have most conspired with workers to exploit consumers—weaken this healthy competition among providers of so-called public services.)
A more subtle use of political power to exploit consumers involves establishing a monopoly or cartel to keep prices up. Cartels are normally very fragile because each member has an incentive to undercut the cartel price to grab business away from his rivals and because monopoly profits attract new competitors. So the police power of the state has been enlisted in many industries to limit entry into the field and to make price reductions illegal. The airlines, interstate truckers, railroads, television broadcasters, U.S. Postal Service, and Ma Bell are obvious examples, as are the licensed professions and trades.
These regulated cartels may have above-average profits for a while, as in the case of television networks, though many come to suffer chronic losses. Some of the potential monopoly profit (from high prices) is usually competed away through nonprice rivalry, such as advertising, and the rest is siphoned off by "specialized resources"—people whose unique skills are essential to the cartelized industry. This explains the relatively high incomes of airline pilots and television celebrities, as well as the affluence of union workers in all regulated industries. If these industries were competitive, they simply could not afford to pay as well, though there would be more jobs available.
The ultimate exploitation of consumers through monopoly prices and onerous taxes is effected, of course, by a nationalized industry. Not only is such an industry a prime target for strikers, but the resulting price hikes are not even constrained by the threat of the firm being forced out of business. If a nationalized industry is pushed to the wall, its managers and other employees just build a pipeline to the Treasury. Look at Britain.
Sports are unique cases of cartels that have survived through government's permission rather than its active participation. The owners of athletic teams have been exempt from antitrust laws and have formed leagues to monopolize the purchase of players. In baseball, for example, the "reserve clause" requires ball clubs to buy a player's contract from other clubs, with a rationing system giving the worst clubs the first chance to "draft" a player. If a team is willing to pay $30,000 a year for a player who is now getting $25,000 from another team, it will end up paying $25,000 to the drafted player plus $5,000 to the owner for his contract.
Such cozy monopoly arrangements have broken down recently, and the result has been to shift the clubowners' monopoly profits to players. This caused a sharp, one-time spurt toward salaries that reflect the true market value of the player's skill; additional spurts in players' incomes will no longer come out of the above-average profits but will instead be limited by the amount of money that can be extracted from consumers. Higher ticket prices result in empty stadiums, which can be self- defeating.
In short, the American people, in their infinite wisdom, generally have a good intuitive sense of when high incomes are being attained by unfair advantages. Those who look to the political-regulatory process for a solution to unfairly high incomes have neglected to notice that political machinations are themselves the cause of the problem.
Although the "man on the street" is generally dismayed only by high incomes that are extracted rather than earned in the marketplace, some people, it is true, are hopped up about any significant income inequality. And they are the most vociferous in advocating political measures to redress such inequality. But they fail to address some hard questions.
On the average, athletes, actors, and other entertainers earn very low incomes. For every millionaire, there are thousands of hungry hopefuls. Like gamblers, such people are willing to take large risks for a very slight chance of making it big for a few years. Most of us prefer a bit more security for ourselves and our families. Many differences in income are attributable to such different tastes for risk. Should the rest of us underwrite risk taking, through food stamps and welfare for those whose gambles do not pay off? Or, should we use the tax system to penalize the successful and thus eliminate the incentive for people to struggle to entertain us better?
Similar thorny issues surround people's different tastes for leisure. We hear a lot about "workaholics" these days and suspect that extraordinary productivity is rough for those who work so hard to do a good job. Yet workaholics surely earn more money than those who spend more time relaxing, playing golf, or with their families. Both those who take their income in the form of leisure and those who take it in cash understand what they are sacrificing.
If we want people to supply us with more goods and services, we might think twice about imposing high marginal tax rates on added income and using the proceeds to subsidize early retirement, long periods of semivoluntary unemployment, disability through alcoholism or drug addiction, and the like. When you tax effort, you get less of it. When you subsidize leisure, you get more of it. Arguments over who is to get the fruits of our labor become moot if the result is less labor and less fruit. We cannot really talk about income distribution as though it were entirely separate from the production inspired by real rewards.
Intellectuals do not really resent actual people with high incomes (generally including themselves). They resent numbers and abstractions, like the share of income or wealth going to the top and bottom fifths of the population. But they are beguiled by misleading statistics.
Income figures for the poorest fifth of all households undoubtedly overstate poverty by neglecting in-kind income (food stamps, housing allowances, Medicaid), assets, and the temporary nature of most periods of low income. Statistics on wealth (what you own minus what you owe) are even more misleading, since upward-bound youth often have both high incomes and high debts, while retired people typically own their homes and other assets and have low debts, low incomes, and modest needs. Moreover, wealth figures omit human capital (the future value of a medical degree, for example) and the present value of Social Security benefits.
Some other neglected aspects of inequality among family incomes are revealed in the accompanying table. The first thing that stands out is that only 1 percent of all families earned over $50,000 a year in 1974 (before paying various taxes taking about 40 percent of their income), while 13 percent of all families earned less than $5,000. You would have to take a lot of income from the 1 percent to provide much help to the 13 percent, and there is no assurance that the "rich" would bother to earn high incomes if you did that.
While the typical low-income family was headed by someone who either was very young or was retired, 85 percent of the high-income families were headed by experienced, well-educated, mature workers. While 45 percent of the low-income families had no member earning income, 70 percent of the high-income families had two or more workers. While a majority of low-income families had only two mouths to feed, a majority of the high-income families had four or more.
Is there anything shocking or scandalous about all this? Don't we all know that incomes rise with education and age and fall at retirement? Don't we know that families in which the husband and wife both work earn more than those in which one is not present or in which neither works? It is difficult to see how this could be changed—or why.
At one time most of us were, or are, struggling young couples and will eventually retire on modest pensions plus accumulated assets. Our retirement incomes may be much lower than when we were raising children and furnishing a house, but our needs will be lower too. The Bureau of Labor Statistics figured in the fall of 1973 that, on an intermediate annual budget, a retired couple could live on $4,500 in many areas and $5,414 nationwide, so a $5,000 income for such a couple in 1974 did not necessarily indicate dire distress.
The main source of income inequality is labor income. Only about one-seventh of all income comes from property (rents, dividends, interest), and even this income is mainly derived from labor earnings that were saved and invested. Such savings and investments channel productive resources into uses that make it possible to increase the supply of goods and services in the future—building machines, factories, and offices. If some of those resources were instead devoted to current consumption, the economy's capacity to produce would be lower in the future, as would average real incomes.
A 1972 campaign slogan, "Money earned by money should be taxed as heavily as money earned by men," was cleverly employed by a McGovern advisor, Joseph Pechman of the Brookings Institution. But two years later Pechman coauthored a Brookings study (Who Bears the Tax Burden?) suggesting that money earned by money is taxed much more heavily than money earned by men. On the most common assumptions about who really pays corporate and property taxes, the Brookings study found that "the average tax rate on income from capital is 33.0 percent compared with 17.6 percent for income from labor."
By taxing capital so heavily, and soaking up available savings through massive government borrowing, public policy has effectively reduced the quantity and quality of tools (capital) available per worker. This reduces output per worker and, what amounts to about the same thing, real income per worker.
Capitalists, including workers with a big stake in pension funds, are probably not greatly injured, since the supply of domestic capital dwindles until its scarcity yields enough to compensate for the tax. Workers, however, are surely impoverished as a result, and the number of attractive job opportunities is reduced.
Many discussions of income rely on a fundamental confusion between money incomes and real incomes and between stocks and flows. Real income is a flow of goods and services over time, not a flow of dollars; and it is not just there, automatically, to spread around however you please. There is never any problem increasing money incomes—just print a lot of crisp new thousand-dollar bills and send one to everyone who is likely to show his appreciation at the polls. That would increase the claims to marketable goods and services, but not the supply of such goods and services. The result would be too much money closing too few goods, and prices would be bid up—as at an auction. This is inflation.
Years ago, economists argued that supply creates its own demand, since nobody would offer anything for sale unless he intended to use the proceeds to buy something. That theory had its flaws, but it was closer to reality than the "new economics," which argues that demand creates its own supply. By putting all the emphasis on stimulating consumption at the expense of investment, recent public policy has developed a chronic inflationary bias. Demand is stimulated and supply is discouraged.
It has become increasingly popular to blame the inflationary consequences of government fiscal and monetary manipulations on private greed. An article in The Money Manager, for example, says that "expectations are rising faster than the ability of overall productive capacity to respond." But greed is a constant; it cannot explain why inflation is higher or lower at various times and in various places. With high expectations and a dollar, you can't buy any more beer than with low expectations and a dollar.
A variation on the theme is that workers "demand" high wages and this is simply passed on in prices. But the sum of wages paid cannot be whatever workers want, because consumer budgets are not unlimited. The demand for labor and its price is derived from the demand for what labor produces. Some workers can benefit at the expense of other workers and consumers by using political devices like licensing laws to keep their skills relatively scarce. This forces more workers into competitive labor markets, thus depressing wages in those markets, and it increases the relative prices of certain products where organized laborers have a monopoly advantage. More money spent on such products leaves less to spend on others, however, so the average of all prices is unaffected.
So-called labor parties seem particularly fond of wage controls—giving politicians and bureaucrats the awesome power to decide what each person's labor is worth. Britain adopts wage controls every few years, in combination with massive budget deficits financed by printing money. The inevitable result is that prices outrun wages, real wages fall, and profit margins widen. With friends like that, laborers do not need any enemies.
There is a tendency, among those who like to think of themselves as supremely scientific, to reduce all ethical issues to social "norms," which are supposedly revealed through the magical properties of the political process. Among these norms are said to be the view that low-income persons are, by virtue of their relative income alone, morally entitled to a portion of somebody else's production and that it is perfectly unobjectionable to compel individuals to support the families of household heads who choose to skip town.
Actually, no serious attempt has been made to defend the ethics of commandeering property that has been obtained by unobjectionable means. The real issue is not the inequality of results, which is bound to occur so long as people are free to exchange goods and services on mutually agreeable terms. The issue is the means by which certain individuals are able to obtain the fruits of others' labor without their consent—essentially, the capture of the tax and regulatory mechanisms by special-interest groups.
As a practical matter, these actions have made property rights less secure and have thus promoted more immediate consumption and less saving. This has further reduced the community's flow of new tools and thereby reduced the flow of real wages and salaries.
Equalizing money incomes, even if it could somehow be accomplished through the political process (in which the poor necessarily have little clout), would not ensure that there would be anything for the money to buy. If there are only enough cars for one-tenth of the population, then only one-tenth can have cars. Existing mansions cannot be divided equally among the populace. The only way that most people can have more goodies is if more are produced.
Have we already gone too far down the road of mutual plunder to turn toward a system that rewards those who best cater to the desires of consumers? Government employees and the recipients of cash aid from the government totaled 36 percent of the population in 1975-up from 22 percent in 1960 and 9 percent in 1940. Government salaries and transfer payments (such as welfare and Social Security) amounted to 56 percent of all private wages and salaries in 1975—up from 35 percent in 1960. These government dependents turn out in droves at election time, making it difficult for those who pay the bills to eliminate any government agency or spending program. Add to their numbers the recipients of non-cash aid and business subsidies, plus the beneficiaries of price regulations, and the task of putting Leviathan on a diet appears formidable indeed. It is now much easier to form a pressure group to get a new special favor from the government than it is to form a coalition of the broad public to avoid getting fleeced by thousands of such maneuvers—each one relatively small, with the costs spread over millions of consumer-taxpayers, but together amounting to a horrendous burden. The usual practice is to rationalize each raid on consumers or the Treasury as providing some indirect benefit to the poor or unemployed, but the working poor usually end up paying far more than they receive. The billions that are spent in the name of the poor are more than enough to eliminate poverty several times over—if that were where the money was really going.
If more and more of us continue to attempt to live at the expense of others, and the portion of the public producing genuinely demanded goods and services continues to shrink, the outlook for growing prosperity and declining poverty will certainly be bleak. We may all get a million dollars, but there won't be much around for those dollars to buy.
Contributing Editor Alan Reynolds is a vice president of the First National Bank of Chicago. His Viewpoint column appears in REASON every third month.
This article originally appeared in print under the headline "Who Gets What".