There is an equivalent of a Laffer curve for inequality, but the variable of interest is economic growth rather than tax revenue. We know that a society with perfect equality does not grow at the fastest possible rate. When everyone gets an equal share of income, people lose the incentive to try and get ahead of others. We also know that a society where one person has almost everything while everyone else struggles to survive – the most unequal distribution of income imaginable – will not grow at the fastest possible rate either. Thus, the growth-maximizing level of inequality must lie somewhere between these two extremes.The "Laffer curve for inequality" is new to me, so I was hoping for a little more in terms of theory, but I guess the rest of the paragraph will have to do. Here's what Mark might have in mind here, though it's hard to tell. From standard neoclassical growth theory, we know that growth in our standard of living is driven by growth an aggregate TFP (total factor productivity), which in turn depends on technological innovation, and the efficiency with which factor inputs are allocated across productive units. Suppose we focus only on technological innovation. Innovators of course need incentives. Innovation is costly, and the reward needs to be sufficient to make it worthwhile. Now, imagine a population of identical people who have two choices: they can engage in risky innovation, or they can engage in subsistence farming. Also, suppose that there is one person - call him Kim Jong-Il - in this society, who has the power to redistribute income at will.
Suppose, on the one hand, that Kim Jong-Il is an egalitarian, and chooses to equalize income across the population. Then, there is no innovation, and this economy will be stuck in subsistence farming forever. On the other hand, suppose that Kim Jong-Il is, well, Kim Jong-Il. He starves the population, actually keeping them below what we would think of as subsistence, but still healthy enough to produce some extra stuff for the dear leader. There is no innovation in this society either, and it remains stuck.
So, now we have two points on the Laffer curve for inequality. What happens in between? Well, there are many ways in which we can redistribute income. We can provide some minimum quantity of a particular service - e.g. health care - for everyone; we can provide insurance against bad events - e.g. unemployment; we can tax some people and use the proceeds to provide public education for anyone who wants it. The effects on innovation will of course have a lot to do with how we do the redistribution. For example, unemployment insurance and welfare could have the effect of deterring innovation through poor incentives, but if the risk of innovation is difficult or impossible to insure through private financial markets, social insurance might actually increase innovation.
This certainly seems interesting. Now, where is Mark going with this? He drops this one:
We may be near or even past the level of inequality where growth begins falling.So, Mark's concern is that we are entering Kim Jong-Il territory, which would certainly be distressing. What's the evidence for this?
The evidence on this is highly uncertain, so it’s difficult to say.So Mark admits to not knowing what is going on, but he's quite willing to bull ahead with a policy recommendation:
But increasingly I am of the view that even if we could level the domestic playing field, it still won’t solve our wage stagnation and inequality problems. Redistribution of income appears to be the only answer.Basically, Mark wants to throw in the towel on education and embark on an income redistribution project. Though the details of the redistribution are critical, Mark avoids specifics.
What do I think? What anyone can see with their own eyes in American cities is appalling. Many of our graduate students come from countries where people are much less well-off than is the average American, and they find it appalling. In many cases, for example here in St. Louis, the first world lives comfortably a short distance from the third world. The dispersion in income across the population in the US is large relative to what it is in other wealthy countries, and that dispersion has increased over the last few decades. Maybe we would not be too bothered by that if we thought that there was high mobility among income classes over time, but we know that there is a significant fraction of the population that is stuck near the bottom.
What's to be done? I'm certain that dumping cash in the inner cities will not promote economic growth in the United States, just as dumping cash in sub-Saharan Africa will not increase world economic growth. The answer has to be education. Here's an example of a sharp economist who has not thrown in the towel. Art Rolnick, recently retired from the Federal Reserve Bank of Minneapolis, has been an advocate of early childhood education. He uses economic evidence, including work by Heckman, to argue that the benefit/cost ratio for funds spent on early childhood education is very large. Further, he puts his time and effort where his mouth is. Indeed, Art embodies what is best in the economics profession: productive work toward a better society using a solid foundation of theory and empirical evidence.