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
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