A Few Questions on EPI & CBPP Income Inequality Report

April 11, 2008

Earlier this week, two economic policy research organizations that tend to favor a larger role for government, the Economic Policy Institute and the Center on Budget and Policy Priorities, released a joint report detailing how income inequality has grown over the past few decades within individual states. The report is available here. From the report, there are two key issues that need to be addressed further: declining living standards for the poor implied throughout the work and why inequality should be addressed by government.

Regarding the claim of declines in the standard of living for lower-income groups, two points need to be made. First, these are groups, and not every household in a given income group stays in that same group over a given period of time. But more importantly, even if a household stayed in the bottom income group for a long period of time, to imply that the standard of living has fallen, there is really only one criterion: is the household better off today than they were in the previous period? In other words, the household must answer no to the following question if its standard of living has indeed declined: “Would you rather have this bundle of products that maximizes your well-being today given your budget or that bundle of products that maximized your well-being 20 years ago given your budget then?” For most households, the answer to that question from even 1990 to today would be yes, and I would be willing to bet for about 99.99 percent of households that stayed in a similar income quintile from 1970 to today would be yes.

With regard to why inequality is even relevant, here’s a quote in the press release from CBPP senior fellow Elizabeth McNichol:

“Rising inequality raises basic issues of fairness, and harms the nation’s economy and political system. It dampens economic prosperity as incomes stagnate for tens of millions of average Americans and it threatens to widen the nation’s political cleavages, generating more cynicism about political institutions.”

Based on the text of the report (see page 12), she appears to be citing a negative externality argument with respect to income inequality when she discusses the political ramifications, arguing in a sense that it is in the self-interest of the wealthy to actually have income redistribution for various reasons (including possibly public health). Although the report doesn’t spell this out, under such an assumption, it is true that government redistributive policy would be necessary because there exists a free-rider problem with relying on voluntary contributions to help mitigate income inequality.

But with regards to the term “fairness” that is thrown around a lot, one must ask why does fairness stop at the border’s edge? If it’s unfair for a high school dropout in Texas to make $15,000 while a doctor in California makes $200,000, isn’t it also unfair for a high school dropout in Texas to make $15,000 while somebody who never had a chance to go to school is earning about $600 per year in Rwanda? Those who advocate redistribution under a fairness doctrine while ignoring inequality on a global scale are either nationalists who only care about those like them or are purely interested in using the term for political rhetoric purposes.

This raises a question relevant to the EPI/CBPP study — why does inequality within a state even matter if fairness is your concern? It is hard to justify an answer to this question. However, inequality within a state’s own borders could matter under the possible externality argument mentioned earlier, assuming that the externality was confined to the state itself and was not a national or global problem, which would imply a role for a higher level of government. The report fails to address this crucial question that is vital to its relevance.

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