Inequality’s Instability Issue

While working through some old papers for a class on political theory, I happened across an interesting (and out-of-place) paper by Allan Meltzer and Scott Richard, “A Rational Theory of the Size of Government“.  It attempts to construct a formal model for how individuals decide their preferences for optimal tax and spending levels based on rational expectations of future earnings.  As it turns out, it’s basically a function of the skew of the income distribution – in highly unequal economies, where the median income is much lower than the mean, the voters will prefer higher taxes and more redistribution.  As it turns out, very high levels of inequality simply aren’t a stable equilibrium.

This is one of the better arguments I’ve heard for why one should not worry about income inequality.  As societies become more unequal and the distribution more skewed, redistribution will become more broadly popular.  Arguably America is in the “correction” phase right now, with some impositions of higher marginal tax rates and Obamacare’s imposition of capital gains surtaxes.  The situation will sort itself out eventually – the longer that elites are able to delay the reckoning through lobbying, donations, etcetera, the greater pressure will build and the sharper the eventual adjustment would be.

Interestingly, one key variable is productivity.  One implication of their model is that gains from growth accrue primarily to those with higher productivity.  When technology is considered as a growth driver, it seems that the most productive become disproportionately more productive with better technology and further the gap between themselves and the median worker.  This is a concept often called “skills-biased technological change”.  As technology improves, the rich get richer. the distribution becomes more skewed and the median income gets further and further from the mean.  This is the world Tyler Cowen describes in Average is Over – and the clear prediction of Meltzer and Richard’s model is that this is a world of incredible pressure for redistribution.

So if liberals believe that automation will wipe out the middle class, they should feel pretty good about the liberal project.  Such a world is one where support for redistribution, and punitive taxes on capital, is widely-shared and politically unassailable.  If you’re a conservative, it should scare the hell out of you.  While conservatives often pay lip service to the idea of spreading opportunity more widely, Meltzer and Richard’s analysis suggest this should be a key policy priority.  Accelerating technology-driven inequality could devastate the constituency for the low-tax, low-service model the GOP stands for today.


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