The McNamara Fallacy Returns: How Inequality Metrics Distract From the Real Causes of Poverty

By David Youngberg. He is an associate professor of economics at Montgomery College. Excerpt:

"Complaints about inequality that rely on political influence are really complaints about cronyism. Cronyism defies easy measurement, but it is what matters, and as long as the focus is on what’s easy to measure, we avoid tackling the underlying issue and the “solutions” just create bigger distortions.

But what about redistribution? Critics of inequality typically pair their concerns with some kind of tax-and-transfer system, and those funds would certainly help struggling families. If you take $1,000 from the rich and give it to the poor, the gap shrinks while the poor’s plight improves. Transfers, funded by taxing the super-wealthy, have a certain logic to them.

Even if the math worked, it’s not so simple. High taxes discourage work and encourage tax avoidance and evasion. The rich spend money on accountants (to find legal workarounds) or lawyers (to defend them if the government catches their illegal workarounds) rather than building new companies and ideas. They eschew high-risk investments when the high rewards that usually go with them are cut to a fraction. Getting rich is sometimes a matter of nepotism or corruption, and sometimes it’s a matter of hard work, thoughtful risk-taking, intelligence, out-of-the-box thinking, and all the things we associate with creating a more prosperous world. Punish that with higher taxes, and society suffers.

Economists call this the equity-efficiency trade-off. The economic pie can shrink as it’s cut more equally, so redistribution can leave the poorest people worse off, not better.

There are super-rich people who got their wealth completely from cronyism, and there are super-rich people who made their fortunes completely by creating and investing in things that make society wealthier. Most are in the vast gray area between: they have created companies that genuinely improved people’s lives but have also used governments to secure protections against competition. How much of each billionaire’s wealth grew the economic pie and how much was due to cronyism? The answer is as hard to measure as Viet Cong morale.

When the emphasis is on the gap between the rich and poor, hurting “the rich” becomes a goal in itself and leads to misidentified threats and misplaced efforts. For example, it’s not just the rich that benefit from cronyism. Occupational licensing restricts competition in jobs nowhere near the top of the income ladder: cosmetologists, taxi drivers, athletic trainers, travel guides, and countless others all drive up prices for everyone, low-income households included.

Unfortunately, tackling this particular problem won’t shrink the income gap because licensed salaries don’t reach the stratosphere. As long as anger is directed at the big numerical gaps, this very real problem doesn’t resonate. But taxing the super-rich, the very-rich, or even the somewhat-rich will “improve” inequality even as investment predictably falls. Inequality metrics decrease as the stated goals are quietly ignored. 

Progressives often tout Europe’s low income inequality as evidence of the success of its generous social programs and broad, heavy taxes that pay for them. Those taxes, paired with a mangled mess of regulation, also stifle entrepreneurship and stunt firms that would otherwise grow. The end result is sobering. After factoring in both taxes and benefits, including health benefits, the median incomes of the largest European economies are 14 to 45 percent lower than America’s. Income might be more equal, but the typical person is worse off.

 

The focus on shrinking the measurable gap makes it harder to achieve much-needed regulatory reform. Robin Hood policies of redistribution might not help the poor, but they will definitely reduce inequality, and as long as that’s what’s prioritized, the real problems linger."