The Mirage of Income Equality: We're Drinking Sand

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One of the more common statist mischaracterizations of laissez-faire is the insistence that laissez-faire promotes income inequality. The only way in which this myth can be true is if laissez-faire is introduced into a polity where people were obliged to become rich, and/or obliged to stay poor. In either case, people are either forced, or obliged through State propaganda, to violate their own marginal utilities of wealth for the sake of conformity to State dictates. The release of that yoke not only releases people to become rich, but it also releases them to not become rich, if they so choose. Since interpersonal comparison of utilities is impossible, there’s no way to predict who will do what, once compulsion is removed.

To recapitulate: laissez-faire can increase income inequality only as a side effect of eliminating State-imposed income conformity. In a State where income conformity is not the prime policy goal, it’s impossible to say whether or not the introduction of laissez-faire would either increase or reduce income inequality. There is only one kind of State that the introduction of laissez-faire would definitely reduce income inequality in: one where legally-imposed income inequality exists. A State in which some people are artificially kept poor, and/or one where State largesse, and/or restrictions, make some people artificially rich, relative to consumer preferences. Historically, the American State has not been one of those.

The modern drive for greater income equality was supposed to be enforced by a highly graduated income tax system. Ostensibly, it was the highly "progressive" income tax that resulted in the "Golden Age of Income Equality" that prevailed in the United States from c. 1945 to 1973.

This simple picture of an equal society, though, has a blot on it — a very significant blot, one revealed by reading contemporaneous liberal complaints about "loopholes." That supposed dam against rising income inequality, when closely examined, offers about as much blockage as a beaver dam, minus the mud. Reading liberals’ complaints about loopholes, made from the late 1940s to the early 1970s, reveals that the cause of the Golden Age of Income Equality was not high marginal tax rates on high incomes.

There is, however, a case to be made that the relatively high level of income equality back then did result from the tax system, if the effect of those loopholes are added. Since high marginal tax rates penalize both investment and growth, any company seeking a loophole could point this out and ask for one, with the "jobs" rationale to make it politically plausible. Since a loophole granted can later be taken away, there was a certain incentive for any company so favored to "spread the gain" by jacking up wages, and by compensating executives non-monetarily — the infamous "three-martini lunch." Another way of compensating executives was granting leisure time, which is not subject to the income tax. An unusually productive executive could gain the privilege of showing up a little late, leaving a little early (especially on Fridays,) and be granted enough time for that three-martini lunch. The privilege of showing up for the afternoon shift while tipsy is also a kind of non-monetary bonus. What this all adds up to, is that income inequality was not reduced as much as advertised during those times. Perks and leisure partially substituted for increases in the pay envelope, at the cost of limiting compensation for productivity increases and therefore limiting productivity increases themselves.

So, economic inequality was in part hidden back then, but there was a reduction in it, as is evident nowadays. It should be noted that the Reagan-era lowering of marginal tax rates on the affluent, the policy widely blamed for increasing income inequality, also included closing a lot of loopholes, in large part through widening the scope of the Alternative Minimum Tax. As a result of both the AMT and loophole closures, it became much more difficult for an affluent person to duck out of paying income tax, though at lower marginal rates. Thus, both income inequality and U.S. government tax revenues have risen in tandem over the last twenty-or-so years.

Another, more politically potent, force for raising income inequality also came into play, one that reveals a fundamental weakness in the policy of reducing income inequality through the tax code. That policy depends upon the taxpayer being kept underfoot: once the question "who pays the government’s bills around here?" becomes politically potent, that policy is on its way out.

Instead, the use of the income tax as a revenue generator becomes a force for increasing income inequality. The person who decides to become rich now, without restraint, has a perfect justification for doing so: "I pay taxes, and the more income I get, the more taxes I pay. Doesn’t that mean I’m kind-of obliged to go for more money?" As a result, the tax-enforced attempt to lower income inequality reverses itself, once the affluent taxpayers wise up to the fact that they’re footing quite a few of the State’s bills — "helping people."

No need to wonder why, as Rep. Ron Paul recently noted, the average CEO salary is close to five hundred times the average worker’s pay. The re-monetization of compensation for increased executive productivity, and consequent release of more productivity, only explains part of the gap’s widening. The income tax system gives perfect justification to such pay disparities, as the State does get its cut. I’m sure that the average CEO would be glad to remind anyone of that fact if his or her pay level was challenged.

The inequality situation has actually gone beyond that self-reversal, though. State intervention in the economy, period, has resulted in unintended consequences. All of them open up the potential for gain. Rep. Paul discussed the massive gains that result from the Federal Reserve’s interventions. Such gains are not confined to "gaming" the Fed, although the most visible gains are had through that. As Hans Sennholz noted, gaming the U.S. Treasury also results in politically-generated profits, and has resulted in a specialist class of political speculators plying their trade. These two types of individuals, highly-paid CEOs and political speculators, do not explicitly include a third elite, also part of the present economy: rent-seekers. All three of these groups have one thing in common: they have gotten affluent, if not rich, through State intervention, and are well equipped to stay affluent, after tax, through influencing the State.

When compared with this new political class, and the current State-caused economic inequality that they thrive in, the old-style businessperson who bragged about paying no taxes on lots of income looks like quite the innocent. Even if his or her "outrageously high income" is compared with today’s figures in real terms.

Daniel M. Ryan [send him mail] is a Canadian with a past. He’s currently wearing out his thumb with pen and paper.

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