Before I begin today’s post, let’s open with a disclaimer: We do not know how the markets will move, we only predict it. We have models that can guess quite well, but like anything, they hold true until the day they do not. And only once they fail will the need for a new model be unavoidable. Today I plan to challenge a common misconception of economic inequality, I challenge a model, by showing that it is not only a moral issue but also an economic efficiency one. So yes, it may go against the postulates of your economic reasoning, but bear with me as I play with an idea that if developed could employ a new basis for market predictions. And if you get through the post and still disagree, please please please reach out about your concerns with my work. I love feedback.
There are dozens of different definitions for economic inequality, therefore, for the sake of consistency, I will use my definition of the term. Economic inequality is the unequal distribution of wealth and opportunity between people. This inequality is what leads to the basic capitalist principle of the rich get richer and the poor get poorer. By limiting people’s opportunities, they have a worse chance of gaining an increased sum of wealth, which then leads to a higher chance of receiving less or the same wealth over their lifetime. Thus, feeding into a continuous cycle that limits the poor from rising and the rich from ever falling in economic status.
One way people have thought to minimize this inequality is through taxation. By raising taxes, the government can fund social welfare programs, which will help the poor and limit the rich. An argument against this philosophy, of increased taxation, is that it is partially counter-intuitive. By increasing taxation, corporations will have a tougher time collecting a profit, which could have gone to improving the lives of their workers. Yet it should be noted that historically “trickle-down economics” has only seemed to remain “trickled up”.
Although, another valid argument against high taxation is commonly referred to as deadweight loss. Deadweight loss is defined as the loss of economic efficiency when equilibrium, for a good or service, is not achieved. The image above represents this concept. Showing an overly simplified market supply and demand curve, you can very clearly see that both the consumers and buyers were able to buy or sell their products at six dollars before any taxation occurred. After the tax, the buyers had to buy their product at seven dollars, while the producers had to sell their product at four dollars. This would not be an issue if the entire amount lost to the market was obtained by the government. Yet as the yellow portion of the second graph shows, this is not the case. Representing the deadweight loss, this portion is the amount of money that was neither received by the government nor the market once the tax was imposed. It is in many respects, wasted money.
The flip side of this introductory-level economics idea is showing the many market efficiencies that taxation can bring. For one, imposing taxes on luxury goods can bring the supply and demand of those products back to its original equilibrium. To elaborate on this idea, a luxury good is a good that is not essential, but instead highly desired and associated with wealth. Examples of these goods include yachts, expensive jewelry, and anything else you don’t need, but you want.
As inequality rises, the wealth within the market begins to funnel into the hands of the few. Morally, this sounds bad, but it is also an efficiency issue. As the wealthy begin to use their wealth and consume products it is only natural that they buy luxury goods. I mean why wouldn’t they? When one has the choice to, why not get the boat that moves faster and looks nicer?
The issue with this increasing demand for luxury goods is that it doesn’t leave much wealth for normal goods. Because of this, normal good prices will increase and demand will decrease. Having a slight increase in the price of eggs may not affect someone making six figures a year, but when all these expensive normal goods begin to add up, one can not be so sure.
The counter intuitiveness of this really shows when this price of living increases because with an increased price of living causes an increased number of people in relative poverty. This then leads to a greater need for social welfare programs, lower demand for common goods, and an overall decrease in the market. By not taxing these luxury goods the demand for such products can have a spiral effect on the economy as a whole.
Another inefficiency derived from low taxation is that the wealthy can only spend so much of their money. Beginning my second reason for taxation, there are only so many cars, homes and whatever else they want until the rich have nothing else to buy. Therefore, the excess money they don’t spend either sits in a bank or the stock market, neither of which is any help to the economy.
*As a side note, I would like to mention that I have heard an argument in favor of investing in the stock market. That by investing in the stock market one can actually boost the economy, but from my experience, all you do as a trader is trade money between other investors. Which adds nothing to the market other than taking a hundred dollars from some eighteen-year-old thinking he can outwit the hedge fund managers and CEOs of the world.
Taking Jeff Bezos for example, he would have to spend twenty-eight million dollars every day to not get richer (DeCambre, 2018). Not alone in this wealth disparity, billions of dollars would need to be spent every day for the wealthy to not suck capital out of the markets. Hence why higher taxation on the upper class is crucial for redistributing money. And do not think this would be an outlandish first time in history to attempt to increase income tax on the wealth. As the graph above clearly shows, income tax percent on the rich peaked from the 1940s to the 1960s. It should also be noted that it was this time, 1940-1970, that the United States went through what we now call today as the Golden Age of Capitalism.
Rolling into my third and final point, this excess wealth does eventually find a purpose, which is called rent-seeking. Rent-seeking is defined as when people attempt to gain benefits through the government. This is mostly done through imposing or opposing a tariff on a product one produces, legalizing, or illegalizing, certain products, or funding campaigns with similar agendas of their own. These practices allow corporations artificial market control. This market power is then used to raise the barrier to entry and decrease competition. All of which will hurt the economy and, once again, begin a ruthless cycle of increased inequality due to an inefficient economy.
Thus, although deadweight cost due to taxation is detrimental, so is an economy that generates more inequality and inefficiencies. To see the efficiency of taxation, whether it be a consumer tax or increased progressive income tax, one needs to look at the greater economic and societal picture and then ask herself which one is really causing the inefficiency.
Next week I plan to discuss another major “inefficiency” that occurs with decreasing inequality. Along with a possible solution that would fix both the moral and market efficiency issue of economic inequality.
Work Cited
DeCambre, Mark. “Amazon’s Jeff Bezos Would Need to Spend $28 Million a Day to Avoid Getting Richer.” MarketWatch, 3 Aug. 2018, www.marketwatch.com/story/amazons-jeff-bezos-has-to-spend-28-million-a-day-just-to-keep-from-getting-richer-2018-08-01.
Mitchell, Daniel. “Historical Rates (Old Definition).” OECD Tax Statistics, 2017, doi:10.1787/data-00268-en.