Economic Equity

The efficiency with which an economy produces output, and the distribution of income within the economy, are not strongly related. An economy may be operating at very high effiency and yet have a very uneven income distribution. Or each individual could have very close to the same income, yet resources could be very inefficiently allocated. All nations act to alter the distribution of income that would result from pure market forces. Governments act to provide income for the aged, the sick and the unemployed. Tax transfers reallocate income from the rich to the poor. The poor and other groups also receive goods in kind like education, food, medical care, etc.

Any program which redistributes income causes some individuals to receive less than their contribution to total output (the value of their marginal product), and others to receive more. Any redistribution scheme, by definition, can only make some people better off by making others worse off in the same total amount. How a society’s income should be distributed is a value judgement and is not subject to economic analysis. Howeer, economic analysis can be used to assess the likely outcome of any proposed redistribution policy. All major political parties advocate some sort of redistribution, some more extensive than others. Since voters choose these parties, we can conclude that voters consider the income distribution arising from a pure market economy to be undesirable on equity grounds, and this can be considered another failure of the market economy.

One way of redistributing income so that everyone has a minimally acceptable ability to provide food, housing and clothing for themselves is a negative income tax. An individual with zero income is simply given, in cash, the desired minimum level of income. As income increases from zero, the transfer is reduced by some percentage of the new income—so that the individual always has an incentive to earn more, but never has to suffer less than the minimum. The problem is that some people don’t consider a cash payment to the poor to be a good idea, because they might spend it on “undesirable” products like cigarettes and booze. This assumes that the poor don’t know where their own interests lie, which undermines the whole theory of markets. And if the poor don’t know where their own interests lie, why should we suppose that the rich do?