Richmond Fed Economists Question Conventional Wisdom on Wealth Redistribution

This is from an email they sent out.

"Conventional wisdom says that wealth redistribution boosts output by increasing aggregate consumption. But economists at the Richmond Fed suggest in the Bank’s latest Economic Brief that household decisions regarding how much to work may offset decisions regarding how much to consume in determining the effects of wealth redistribution.

The authors conclude that wealth redistribution may have little effect on output and might actually reduce it. They are careful to note, however, that redistribution is not necessarily bad. “Allowing people to retire earlier or enabling secondary earners to drop out of the labor force to, for example, help take care of children or elderly parents, are significant benefits to the recipients of a redistributive program,” they write. “Those benefits might be good reasons in and of themselves to redistribute wealth, even if they have little to do with the more standard rationale and rhetoric surrounding boosting output.”"

Here are excerpts from the study

"The conventional rationale for redistribution is that lower-wealth households have a higher marginal propensity to consume — that is, they are more likely than higher-wealth households to spend an extra dollar received than to save it. This occurs because less wealthy households are generally more likely to be affected by liquidity constraints, that is, a limit on the amount they are able to borrow against future income in order to fund their desired current consumption level. As a result, transfers to lower-wealth households would boost aggregate consumption. This redistribution then has a stimulative effect on output because, in a standard Keynesian framework, an increase in the demand for labor is met with higher employment.²

This view puts household heterogeneity, with respect to both wealth and consumption behavior, front and center in determining the aggregate short-run response to a change in transfers. In recent research, Kartik B. Athreya, Andrew Owens, and Felipe F. Schwartzman show that the effect of a wealth redistribution program likely depends critically on another type of heterogeneity: how the marginal propensity to work varies with wealth.³ If recipients of a redistribution of wealth are likely to drop out of the labor force and contributors are not more likely to increase their hours worked, wealth redistribution programs could have contractionary effects on output and employment, even if there is a short-run increase in consumption. In other words, the stimulative impact of a redistributive policy is a function of how the marginal propensity to work, more than the marginal propensity to consume, varies with household wealth."


"While lower-wealth households generally will increase their consumption as a result of the transfer, they also are able to increase their leisure. This increase in leisure leads to a decrease in labor supply and thus, potentially, to a decline in aggregate output. However, contributors to the transfer — that is, the higher-wealth households — might increase their labor supply and reduce their leisure. This countervailing effect is especially likely to be important to the extent that higher-wealth households are more productive, so that a small increase in their labor supply can make up for large decreases in the labor supply of less-wealthy and less-productive households.

The authors find that labor supply decreases for households in the bottom four quintiles of the wealth distribution, with the largest decreases in the first and second quintiles. Households in the top quintile increase their labor supply, but not enough to offset declines in the other quintiles. Still, although there is a decline in aggregate hours worked, effective hours worked changes only slightly; assuming the wealthy earn higher wages because they are more productive, the increase in labor supply among those in the top quintile offsets the decline in labor supply among the bottom quintiles. This helps to dampen the contraction in output that results from the fall in labor supply."

"Still, under a reasonable and realistic set of assumptions, labor supply plays an important role and is an important complicating factor that requires more investigation. Currently, there is a large body of work on how the marginal propensity to consume varies with wealth but very little research on how the marginal propensity to work varies."

"Although Athreya, Owens, and Schwartzman's results suggest that a redistribution of wealth would have at best little effect on output, and might actually reduce it, they should not necessarily be construed as saying that redistribution is bad."