All Commentary
Monday, May 1, 2000

Pulling Us Apart

Income Gaps Resulting from Voluntary Exchange Are Desirable and Just

Recently, two Washington, D.C., think tanks—the Economic Policy Institute and the Center on Budget and Policy Priorities—issued a study of the income gap between rich and poor American families titled “Pulling Apart.” According to the authors, by the late 1990s average income among families in the top 20 percent (top quintile) of the income distribution was $137,500, while that of families in the bottom quintile was only $13,000—a gap factor exceeding ten. In nine states the gap factor exceeded 11, and since the late 1970s the income gap had increased in 46 states.

The authors attribute the gaps to such factors as the growing importance of skilled labor relative to unskilled labor; the increasing value of higher education; the decline of low-skilled manufacturing employment; increased immigration; the stock market boom, which disproportionately benefits higher income people; and declining unionization. Except for the latter, all those factors have, indeed, affected the “distribution” of income.

The authors imply the gaps are unjust, and they propose remedies. “Through policies such as raising the minimum wage, strengthening unemployment insurance, implementing a wide range of supports for low-income working families, and reforming regressive state tax systems, state and federal lawmakers can help moderate the growing income divide.”

There are at least three things wrong with this study. First, its authors have overstated the size of the gaps. Second, they ignore the fact that families and individuals move from quintile to quintile. Finally, gaps, no matter how large, if they are the result of voluntary exchange, are no cause for alarm. They are both desirable and just.

The authors based their work on pre-tax data from the Census Bureau’s Current Population Survey (CPS). In September 1999 the Heritage Foundation published a study that shows that CPS data systematically overstate income gaps. For example, in 1997, according to CPS data, families in the top quintile received 49.4 percent of total household income, while those in the bottom received only 3.6 percent. When the data are corrected to take into account the effect of taxes, government subsidies, and capital gains, the two figures are 45.3 and 5.6 percent respectively. When the data are further adjusted to put an equal number of people, rather than families, in each quintile, the numbers are 39.7 and 9.4 percent, respectively. Therefore, all the gaps in “Pulling Apart” are exaggerated.

A quintile distribution of income is a snapshot of family income at a point in time. Suppose that the 1990 distribution indicates the top quintile received 50 percent and the bottom quintile 6 percent of total income, and that the 1999 distribution shows the same. This does not mean that the people in the bottom or top quintile in 1990 are still in the bottom or top quintile in 1999. Some people in the bottom in 1990 will have moved up to higher quintiles, even the top, by 1999. Similarly, some people in the top quintile in 1990 will have moved down to lower quintiles, even the bottom, by 1999. An unchanging quintile distribution is perfectly consistent with some poor getting richer and some rich getting poorer. A study reported by the Federal Reserve Bank of Dallas indicates that 29 percent of the families in the lowest quintile in 1975 had moved to the top quintile in 1991. Only 5.1 percent of those in the bottom in 1975 remained there in 1991. In a free-market economy there is constant movement. Quintile distributions themselves mean very little.

Hooray for Gaps

The very term “income distribution” implies that there is a given total lump of income that belongs to everybody that must be divided up by some authority. But in a market economy, income is created by voluntary exchange between people. Each individual owns the income he creates. The distribution (use) of his income is for him to decide. Abstracting from sheer luck, in an economy based on voluntary exchange there is only one way to create income: giving other people opportunities to make themselves better off by agreeing to exchange with you. It is desirable for those who serve others well to have higher incomes than those who don’t, because those differences provide incentives for people to try to serve others as best they can. Widespread prosperity comes from widespread efforts to serve others well.

If you choose your occupation on the basis of what you like to do without regard to what other people are willing to pay you to do, you may end up happy but poor. I like to sing. But no one is willing to pay me to sing. So I talk and write for a living. If I chose to sing for a living I would be justly poor. My poverty would give me no legally enforceable moral claim to the incomes earned by other people. I would have chosen to be poor.

Some people choose to save and invest part of the income they create. In doing so, they provide the means for entrepreneurs to undertake new ventures, create new products, and provide new employment and purchase opportunities for people. Other people consume most of their incomes. Savers and investors are likely to accumulate assets that will generate more income for them than the spendthrifts will have. Yet spendthrifts have no legally enforceable moral claim on the incomes of savers and investors. The authors of the study may want to grant people who make poor choices an enforceable claim to the incomes of people who make better choices, but there are no moral grounds to do so. Of course, anyone is free to redistribute his own income, but no one has a moral right to redistribute incomes created by other people without their consent.

Whose Equality?

Jefferson proclaimed that it is “self-evident that all men are created equal.” He meant that all people have the same natural rights and that a just government is one that enforces them equally for all people. It is also self-evident that all people are not created equal in terms of mental and physical abilities, alertness, attitudes, and other human attributes. In a market economy those natural differences inevitably result in different people creating different amounts of income and wealth. As Hayek pointed out, for government to impose an income distribution different from the one that emerges spontaneously in the market, government has to “treat unequal people unequally.” Governments impose income distributions by taking from some people and giving to others. The victims of the takings are treated one way by government, and the recipients of the takings are treated another way. If a government wants to impose a more equal income distribution to mitigate the effects of natural human inequalities, it must discard Jefferson’s principle that a just government must treat all people equally under the law. We have already gone far down that road, and it has already pulled us apart. The authors would have us go further. Like socialists around the world, they think there is never enough coercive redistribution.

  • Charles Baird is a professor of economics emeritus at California State University at East Bay.

    He specializes in the law and economics of labor relations, a subject on which he has published several articles in refereed journals and numerous shorter pieces with FEE.