Fisking Posner on Inequality

posted by Frank Pasquale

In a recent post on the B-P blog, Richard Posner addresses soaring inequality. In the U.S., “since 1980 the percentage of total personal income going to the top 1 percent of earners has risen from 8 percent to 16 percent.” He concedes a few bad effects from this situation, but ultimately concludes that, aside from upping the estate tax, nothing should be done. My favorite part of the post involves Posner’s speculation that “[m]assive philanthropy directed abroad can interfere with a coherent foreign policy;” fortunately, the administration is already on the case.

It’s astonishing how assiduously Posner ignores the work of Robert H. Frank. In 20 years of rigorous articles and books, Frank has documented over and over the ways that growing inequality harms society. Some of us in the legal profession have applied his theories; Cass Sunstein on cost-benefit analysis, Richard McAdams in Relative Preferences, and my own work on luxury health care and the rise of low-volume, high-margin business models in IP.

But in this post, and even in longer treatments of the subject, Posner ignores the leading American theorist on the consequences of economic inequality. Frank takes his libertarian critics seriously, but somehow falls under the Posner’s radar. (Even in articles published in Westlaw, where a search for [au(posner) and ("robert frank" or "robert h. frank")] got no hits evidencing engagement with Frank’s work on inequality.)

In what follows, I try to “fisk” Posner’s account of the effects of inequality.

From: Should We Worry about the Rising Inequality in Income and Wealth?–Posner

[An excerpt of Posner's post is below; my comments are in italics.]

What are the causes, and what are the effects, of this trend in the income (and of course wealth) of the highest-earning segment of the distribution? . . . . Marginal income tax rates on the wealthy have not declined much in recent years,

What were they during the last war?

however; but the income tax rate cuts since 2001 have favored the wealthy. Another and more important factor in the recent wealth surge is a growing return to high IQs; outstanding success in highly complex fields such as finance and software is highly correlated with high levels of intelligence.

This is intuitively plausible, if we think about the vast ranks of people making between, say, 50 and 350K per year in such fields. But you said you’d be focusing on the very top. Do you really think that breaking out from, say, 200K p.a. to 1M p.a. is so highly correlated to IQ? Has anyone done good empirical work disaggregating positive things like drive, ambition, intellectual and personal skills, and negative or neutral things like connections, luck, nepotism, insider knowledge, etc.?

And increased size of markets as a consequence of increased international trade provides greater returns to successful innovations.

I am more interested in the effects of the increasing incomes of the rich–though one might ask: are there any effects, other than those that are perfectly benign? Even though the federal income tax is increasingly a proportional rather than a progressive tax (though it is still somewhat progressive–the average tax rate for the top 1 percent of earners–24 percent–is roughly twice that for all federal taxpayers), the more skewed the distribution of income, the higher the proportion of taxes that is paid by the rich.

As are the enjoyment of the benefits of order, as Lincoln Filene noted.

And in fact the top 1 percent of earners pay more than one-third of all federal income taxes today, which is a boon to the rest of the population. Very wealthy people also provide patronage for the arts, funds for high-risk ventures (actually, art is one of those ventures), and money for philanthropic enterprises.

As Stephanie Strom reported in the NYT, just about 10% of charitable contributions go to the poor. There isn’t much redistribution going on here.

And there is very little envy of the rich on the part of other Americans, in part perhaps because of the much-derided but very real “trickle down” effect.

Again, some evidence? Some links to something validating the trickle down effect? At this level of abstraction and lack of support, one can just as easily tell a “just so” story about an auction effect: higher earners bidding away relatively fixed resources (be they doctors, nonrenewable energy, or land near a train stop) from the rest of society. Posner doesn’t merely fail to weigh the “trickle-down” effect against the “auction effect”–he doesn’t even mention the latter.

This is due partly to philanthropy but more to the enormous consumer surplus generated by products such as Microsoft Windows, the brainchild of persons who are now billionaires.

Hmmm–did various FUD strategies used to deter competitors also increase consumer welfare?

It is also due in part to the fact that, given diminishing marginal utility of income, income increases at lower levels in the income hierarchy increase personal welfare more than increases at higher levels do.

Given “diminishing marginal utility of income,” we really shouldn’t worry that much at all about progressive taxation on people who earn, say, over 1 million dollars per year, or have $20M in wealth. But I don’t expect Posner will be deploying the concept in that direction any time soon.

Moreover, real wealth is a function of improvements in the quality and variety of products and services, and these improvements benefit all classes of the population.

All this is not to say that the existence of a stratum of exceedingly wealthy people is altogether to the good. There are three potentially bad consequences for our society:

1. The existence of enormous financial returns to IQ

wait a second–have you proven these are returns to IQ? Isn’t it possible that many of these people inherited the money? got lucky? Certainly even if wall street returns are random, 4 or 5 stockbrokers out of a thousand will nevertheless choose correctly each year for 8-10 years–are these people somehow far better than their peers?Anyone familiar with the discussion of polarization of professional salaries in Frank & Cook’s Winner Take All Society would not be so quick to assume that IQ, or even merit, explains the gap in earnings. As their examination of the polarization of dentists’ incomes shows, it may just arise out of greater willingness to serve the wealthy. I’m not saying that’s wrong–I’m just saying that a great dentist serving the poor is going to be making a lot less than a great dentist serving the poor.

deflects high-IQ people from entering careers in which the social returns may greatly exceed the private returns: government service, basic science, and teaching. The quality of both the civil service and the public schools appears to be falling.

But the problem is certainly bigger than that. There’s a reallocation of people within professions–from, say, primary care to plastic surgery, or from community hospitals that provide charity care to specialty hospitals unburdened by ERs. We might expect a drain of the most ambitious from all manner of service professions, into the financial sphere.

2. Massive philanthropy directed abroad can interfere with a coherent foreign policy. Major philanthropies such as the Gates Foundation do not coordinate their spending decisions with U.S. national goals.

And which U.S. policy goals might they be contradicting? Have things gotten this bad?

3. Huge personal wealth may play a disproportionate role in political competition.

May?

Personal wealth confers an enormous advantage on a candidate, but also permits a person who does not want to be a candidate to exert an influence on candidates and policies, as in the case of Richard Mellon Scaife and George Soros. The fact that a person is a highly intelligent speculator, such as Soros, is no guarantor of political insight or wisdom; and the fact that a person has inherited a vast fortune, such as Scaife, is no guarantor of ability of any sort. More important, however, heavy campaign spending by the wealthy force nonwealthy candidates to spend increased time and effort on fund raising, which makes a political career less attractive to nonwealthy persons and makes nonwealthy politicians less well informed about policy and more dependent on interest groups than if campaign spending were lower.

Are these consequences serious enough to warrant remedial action? I think not,

Glad that’s settled.

except that they may provide some grounds for wanting to retain, perhaps even to strengthen, the estate tax. The disincentive effects of taxing estates are much less than those of income taxation.

I like the policy concession, but I don’t see how we can make such a “surgical strike” against economic orthodoxy. Think about Liebowitz & Margolies’s response to the economists’ brief in the Eldred case–there are many business enterprises (and people) who could care quite rationally about income streams into the far future.

Bottom line: The wonderful thing about blogging is that you can link to things that support your position. I hope to see Posner doing more of that in the future, and taking on some worthy opponents, like Robert Frank.

PS: Here’s an excerpt from a short piece on “The New Inequality:”

This year, a new economic statistic that casts doubt on the old consensus [about education-driven inequality] began getting some serious attention. Over the last five years, the average pay of college graduates grew at only a little better rate than inflation. For now, most holders of bachelor’s degrees appear to be on the wrong side of the inequality divide, which suggests that the slice of the American work force on the right side of the divide has become extremely narrow. Even families at the 90th percentile of the income distribution (now earning about $110,000 a year) have received only a marginally bigger raise over the last decade than those in the middle of the distribution.

 December 16, 2006 at 10:26 am   Posted in: Economic Analysis of Law, Intellectual Property, Legal Theory, Technology    Print This Post

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