Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.
PART 6 The Economics of Labor Markets
Chapter 20 of 36 Income Inequality and Poverty
Section 11 of 20
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We have discussed how the economy's income is distributed and some of the problems in interpreting measured inequality.
This discussion was positive in the sense it described the world as it is.
We now address a normative question facing policymakers - what should government do about economic inequality?
Views on this question are largely a matter of political philosophy.
Three prominent schools of thought in political philosophy are
· utilitarianism
· liberalism
· libertarianism
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Utilitarianism
The founders of utilitarianism are the English philosophers
· Jeremy Bentham (1748-1832)
· John Stuart Mill (1806-1873)
The starting point of utilitarianism is the notion of utility - the level of happiness or satisfaction a person attains.
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Utilitarians hold utility (well-being) should be the ultimate objective of all public and private actions.
They claim the main goal of government should be to maximize the sum of utility of everyone in society.
The utilitarian case for redistributing income is based on the assumption of diminishing marginal utility.
An extra income dollar provides a poor person with more additional utility than an extra dollar provides a rich person.
As a person's income rises, the marginal utility resulting from an additional dollar of income falls.
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This assumption of diminishing marginal utility, together with the utilitarian goal of maximizing total utility, justifies the belief government should have policy goals of achieving more equal income distribution.
For example, Peter earns $80,000 and Paul earns $20,000.
The government taking a dollar from Peter and giving it to Paul will reduce Peter's utility and raise Paul's.
Because of diminishing marginal utility, Peter's utility falls less than Paul's rises.
This redistribution of income raises total utility in society.
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The utilitarian argument may seem to suggest the government should continue to redistribute income until everyone in society has the same income.
Actually, utilitarians reject complete equalization of incomes, because they accept one of the Ten Principles of Economics: people respond to incentives.
Under the U.S. federal income tax and welfare system, people with high incomes pay high taxes and those with low incomes rather than pay taxes receive income transfers.
But, if the government takes away too much income from high earners and gives it to low earners, both Peter and Paul have less incentive to work.
When they work less, society's total income and total utility falls.
Therefore, the utilitarian government has to balance the gains from greater equality against the total income losses resulting from reduced work incentives.
To maximize total utility the government must not try to make society fully egalitarian.
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Imagine Peter and Paul are trapped at different places in the desert.
Peter's oasis has much water, Paul's has little.
If the government could transfer water from one oasis to the other without cost it would maximize total utility from water by equalizing the amount of water in the two places.
But suppose the government only has a leaky bucket.
As it moves water from one place to the other, some of the water is lost.
In this case, a utilitarian government might try to move some water from Peter to Paul, depending on the severity of Paul's thirst and the quantity of water that leaks from the bucket.
But with a leaky bucket, a utilitarian government would, or should, refrain from trying to reach complete equality.
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