Why Income Redistribution Fails

Elizabeth Warren has proposed economic "plans" to effectively take the assets of one group of citizens and give them to another. Many think she is giving those stolen assets to those in need, but instead they will go into the pockets of government, swelling the public sector at the expense of the private sector.

The note below is a simple parable from Brian Westbury highlighting the folly in Warren's idea.  Enjoy.

Income Inequality, Taxation, and Redistribution

One of our favorite economic parables is the Fish Story, from Paul Zane Pilzer’s 1990 book, “Unlimited Wealth.”  It is an excellent tool for thinking about wealth creation, inequality and redistribution.

 

Imagine 10 people live on an island.  Each day they wake up, catch two fish, eat them, and go back to bed.  Its subsistence living at the most basic level.  There are no savings – no stored or saved wealth.  If someone gets sick and can’t fish, there’s no way to help them.  No one has any extra.

Now imagine two of these people dream up a boat and a net.  They spend six days catching one fish per day, slowly starving, but they make the boat and net.  On the 7th day, they go out into the ocean and catch 20 fish in the net – it worked!!!!

At this point, the island can go one of two ways.  First, since two people now produce what previously took ten, resources are freed up to do other things.  Farming corn, picking coconuts, cleaning fish, cooking, repairing the boat and net, the possibilities are endless.  The island ends up with more (and better!) food, new technologies, higher standards of living, more assets, more wealth, and they can now afford to take care of their sick and vulnerable!

Or…the eight people who don’t have a boat and net could become envious.  Two now produce ten fish per day, while everyone else can only produce two.   Income inequality now exists:  it’s no longer 1:1, it’s 5:1.  So, they devise a plan to tax 80% of the income of the boaters (16 fish) and redistribute two fish to each of the other inhabitants.

If the second plan is adopted, no one is better off.  Each inhabitant still only has two fish.  Moreover, the entrepreneurs have no incentive to fix their boat and net.  The island will eventually revert to subsistence.

This is the problem with taxation for redistribution: it robs the economy of the benefits of new technology.  Certainly, some of our brothers and sisters need help, sometimes permanently; sometimes temporarily.  However, taxation for redistribution doesn’t make the economy stronger; redistribution hurts growth.

Everyone on the island is better off because of the boat and the net.  Taxing the inventors’ wealth or income and redistributing it removes resources from a highly productive new technology.  Moreover, the income inequality that exists on the island is a sign of more opportunity, not less.

There are things the government can do that add to productivity – police and fire protection, national defense, enforcing the rule of law and protecting private property – but once government goes beyond this, it begins to undermine growth.

Today, 17% of all personal income is redistributed by government, while around 40% of all income is taxed and spent by the federal, state and local governments, combined.  This is the reason the US economy has not attained 4% real GDP growth.  European economies tax and spend even more and this is why they have grown slower than the US in recent decades.

In the meantime, government leaders around the world blame slow growth on a lack of investment by companies and attempt unsuccessfully to use negative interest rates to stimulate lending and investment.  They also propose even more government spending and redistribution to help those that big government is holding back.

These policies won’t boost growth, and proposals to tax wealth and income because of the perceived problem of income inequality will ultimately reduce living standards.  Increasing living standards requires less government, not more.

Brian S. Wesbury - Chief Economist

Robert Stein, CFA – Deputy Chief Economist    

Summary of the Democratic Party Platform

The first Democratic debate was quite the "promise-fest", with candidates one-upping each other with promises of more goodies for We the People.  In today's Wall Street Journal, Karl Rove compiled a summary of the promises and crafted it into a potential speech for the Democratic nominee for President. Enjoy! 

“Trump is a phony, a pathological liar and a racist. He’s the divider in chief, the bully I’ve known my whole life. To him, white supremacists are ordinary, decent people. It is now time to restore the nation’s soul. This president has ripped it out.

“Our economy is rigged for corporations and the very wealthiest. It does great for a thinner and thinner slice at the top, for giant drug companies and oil companies, but isn’t great for everyone else. That is corruption, pure and simple. Nothing will change unless we take on Wall Street, the big pharmaceutical firms, the military-industrial complex, the fossil-fuel industry and big-money interests and make structural changes to our government, economy and country.
“Health care is a basic human right—and it’s worth fighting for. The best way to provide it is Medicare for All. If that means abolishing private health insurance in favor of a government-run plan, so be it. There are too many people profiteering off America’s pain, from drug companies to insurers to hospitals. Moreover, we do ourselves no favor by having 11 million undocumented people in America without health-care coverage.
“It’s also time to repeal the Hyde Amendment, which forbids using taxpayer dollars for abortions. I can’t justify leaving millions of women who are dependent on government support without a way to lawfully access abortions. And let’s not forget that if a trans woman is poor, that doesn’t mean she shouldn’t have the right to an abortion.
“We can no longer ignore the existential threat of climate change. We have to confront it before it’s too late. Scientists tell us we have only 12 years before there’s irreparable damage to our planet. That is why I support a Green New Deal to transform how we treat the environment, taking the world away from fossil fuels and toward energy efficiency and sustainable energy.
“We need to commit to free college for all our children. College shouldn’t just be a privilege for those who can afford it. We must make public colleges and universities tuition-free and eliminate all $1.6 trillion in outstanding student debt. We owe it to our young people.
“We can afford these changes. I would start erasing America’s enormous income inequality by eliminating Trump’s tax cuts for the wealthy. We can pay for free health care and college by putting a speculation tax on every stock trade on Wall Street. I’m tired of freeloading billionaires. There should be a 2% annual tax on household wealth in excess of $50 million and a 3% tax on every dollar above $1 billion.”

“I’ve been asked, would I put any limits on abortion? I would make certain that every woman has access to the full range of reproductive services. That includes birth control, abortion—everything a woman might need. Judges must be 100% clear that they will defend Roe v. Wade or I won’t appoint them. That’s my litmus test. To defend Roe, we may have to add Supreme Court justices—expand the court’s numbers by five to 10 or have a rotating pool of justices. I’m taking nothing off the table.

Let's hope none of the policies come to fruition or the economic outlook for the US will be similar to that of Europe-which is awful. 

Cheers

Ned