Reducing poverty, not inequality

Public Interest, Fall, 1999 by Martin S. Feldstein

According to official statistics, the distribution of income has become increasingly unequal during the past two decades. A common reaction in the popular press, in political debate, and in academic discussions is to regard the increased inequality as a problem that demands new redistributive policies. I disagree. I believe that inequality as such is not a problem and that it would be wrong to design policies to reduce it. What policy should address is not inequality but poverty.

The difference is not just semantics. It is about how we should think about the rise in incomes at the upper end of the income distribution. Imagine the following: Later today, a small magic bird appears and gives each Public Interest subscriber $1,000. We would all think that this is a good thing. And yet, since Public Interest subscribers undoubtedly have above average incomes, that would also increase inequality in the nation. I think it would be wrong to consider those $1,000 windfalls morally suspect.

Pareto principle vs. Gini coefficient

When professional economists think about economic policies, they generally start with the principle that a change is good if it makes someone better off without making anyone else worse off. That idea, first suggested by the Italian economist Vilfredo Pareto, is referred to as the Pareto principle. I find it hard to see how one could disagree with such a principle, which is why it is the widely accepted foundation for the evaluation of economic policies.

Not all policies can be evaluated in reference to the Pareto principle. There are policies that make some people better off while making others worse off. The desirability of such a policy depends on how much the gainers gain, how much the losers lose, and the initial income and circumstances of the individuals involved. But that difficult evaluation is not my concern here. I am interested only in evaluating changes that increase the incomes of high-income individuals without decreasing the incomes of others. Such a change clearly satisfies the common-sense Pareto principle: It is good because it makes some people better off without making anyone else worse off. I think such a change should be regarded as good even though it increases inequality.

Not everyone will agree with me. Some see inequality as so intolerable that they regard increasing the income of the wealthy as a "bad thing," even if that increased income does not come at anyone else's expense. Such an individual, whom I would describe as a "spiteful egalitarian," might try to reconcile this with the Pareto principle by saying, "It makes me worse off to see the rich getting richer. So if a rich man gets $1,000, he is better off and I am worse off. I don't have fewer material goods, but I have the extra pain of living in a more unequal world." I reject such arguments and stick to the basic interpretation of the Pareto principle that if the material well-being of some individuals increases with no decrease in the material well-being of others, that is a good thing even if it implies an increase in measured inequality.

I would note that one can reject spiteful egalitarianism and still favor redistributive policies and tax progressivity. Such redistributive policies reflect an assumption that the social value of incremental income (in economic terminology, the social marginal utility of income) declines as income rises i.e., that an extra $100 of income means less to a millionaire than to someone whose income is $10,000. Of course, many economists reject such comparisons on the grounds that there is no way to compare how much pleasure two different individuals get from money or from the goods that money buys. But analyses that conclude that all increases in inequality are bad imply something much stronger: that the social value of incremental income to a rich person is actually negative.

More formally, economists and other policy analysts often use the "Gini Coefficient" as a measure of income inequality.(1) The Gini Coefficient measures the concentration of incomes in the nation, with a higher Gini Coefficient value implying more concentration. A feature of the Gini Coefficient is that an increase in the incomes of the rich with no change in the incomes of others will raise the Gini Coefficient. The common procedure of regarding a higher Gini coefficient as a deterioration of the national condition is equivalent to treating the social marginal utility of high incomes as negative - i.e., that something bad has occurred when the well to do become better off.

In rejecting the criticism of inequality per se, and in asserting that higher incomes of the well off are a good thing, I am not referring to the functional arguments that some have offered in defense of inequality. Such analysts argue that an unequal distribution of income may contribute to general economic growth, and therefore to the poor's standard of living, by increasing the national saving rate. Alternatively, they contend that inequality is a reflection of Schumpeterian innovation, which eventually helps most, if not all, individuals in the economy. I am also not defending high incomes because the affluent support charitable causes or "high culture." All of this may be true, and even convincing to someone who doesn't care about the well-being of the wealthy or who gives negative weight to their increased well-being. But I am not relying on such arguments here, because I want to stress that there is nothing wrong with an increase in the well-being of the wealthy or with an increase in inequality that results from a rise in high incomes.