Goossens Maxime

I6158113

The American Dream… of Inequalities…

Student number I6158113

Surname, First name Goossens Maxime
Email (UM) maxime.goossens@student.maastrichtuniversity.nl
Study International Business

Course code EBC1009

Group number 22
Writing tutor name Foster, A (Angus)

Writing assignment Main Paper

Place and date 01/12/2018

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Table of Contents
Introduction................................................................................................................................3
Evidence of economic inequality in the US...............................................................................3
Problems and consequences of inequality:................................................................................4
Advantages of inequality............................................................................................................6
Inefficiency taxation...................................................................................................................6
Deadweight loss.........................................................................................................................6
Causes of inequalities.................................................................................................................7
Solutions.....................................................................................................................................9
Conclusion................................................................................................................................10
References................................................................................................................................11
List of graphs............................................................................................................................12

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Introduction

Since the nineteenth century, purchasing power and the level of education of the world
population have improved, especially in the USA. Economic inequality, however, is back to
where it was at that time, which seems counter-intuitive. In this paper on economic
inequality, we will focus specifically on income distribution inequality as defined by the gap
of income between the population of a country (the poor vs. the rich) or among countries
(developing vs. developed countries). Inequality is a very topical, as well as vast and
multidisciplinary subject combining many fields of social sciences such as economy, society
and politics. We will first highlight evidence of (rising) inequalities in US. Then, we will run
through the main problems caused by inequality as well as the (few) advantages that it can
bring to society. The paper ends with a review of some solutions to fight inequality.

Evidence of economic inequality in the US

In the last two hundred years, a lot of factors have influenced the world and its economy,
such as authoritarianism, communism, wars, industrialization, globalization and, quite
recently, a severe financial crisis, but overall the world has experienced economic expansion.
Indeed, as shown in Graph 1, the USA GDP over two centuries has increased by more than a
thousand percent, much faster than population growth over the same period, +32%. (United
States Census Bureau, 2010). Intuitively, we would assume that the population has benefitted
from this growth, spread equally across all socio-economic layers. As difficult as it may be to
believe, inequality has not decreased since the nineteenth century, even worse it increased
and that trend seems to be continuing. As show by Piketty and Saez (2003), since 1970,
income has grown, but in a non-proportional way in society. In the US, the income of the top
one percent of earners has grown stronger than the average. From 1973 to 2010, the share of
income earned by the wealthiest one percent of the US population rose from 7.7% to 17.4%.
In addition, looking at the Gini coefficient, which measures inequality, it has increased since
1820. In fact, according to Hillebrand (2009), the global Gini coefficient has risen from 0.50
to 0.68 (ie. inequality has increased) since 1820 (see Figure 2.). Interestingly, inequality is a
vast subject which involves not only economy, but also other social science disciplines
including society and politics.

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Figure 1. Historical US GDP from 1820 to 2010

16,000

14,000

12,000

10,000

8,000
USD bn
6,000

4,000

2,000

0
1820 1870 1913 1950 1973 1988 2010

Source: Oecd.org. (2018). OCDE - OCDE. [online] Available at: http://www.oecd.org/fr/index.htm [Accessed 9

Dec. 2018].

Figure 2. World Gini estimates

Source: Hillebrand, E. (2009). Poverty, Growth, and Inequality over the Next 50 Years. FAO, United Nations –
Economic and Social Development Department.

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Problems and consequences of inequality:

To understand the problems caused by inequalities, a study by Wilkinson and Pickett (2011)
claims that inequality is more important in modern and developed countries due to income
distribution. In addition to that, as reflected in Figure 3. and Figure 4., they found a strong
correlation between inequalities and social problems, such as criminality, lack of community
life, obesity or drug problems. To illustrate this, the US homicide rate in 2015 was 5.2 per
100,000 inhabitants, compared to 0.3 in Japan and 0.9 in the Netherlands (OECD, 2015).
Wilkinson and Pickett’s book was much debated when it was published, with left-wing
politicians agreeing and willing to fight inequalities while conservatives were more likely to
criticise the study. In any case, taking measures to reduce inequality should help to tackle its
undesired consequences, helping to improve the overall quality of life of the entire
population.

Figure 3. Health and social problems are not related to average income in rich countries

Source: Equalitytrust.org.uk. (2018). The Equality Trust | Working to improve the quality of life in the UK by
reducing economic inequality. [online] Available at: https://www.equalitytrust.org.uk/ [Accessed 9 Dec. 2018].

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Figure 4. Health and social problems are worse in more unequal countries

Source: Equalitytrust.org.uk. (2018). The Equality Trust | Working to improve the quality of life in the UK by
reducing economic inequality. [online] Available at: https://www.equalitytrust.org.uk/ [Accessed 9 Dec. 2018].

Advantages of inequality

According to Mankiw (2013), there are only a few advantages of inequality, the main one
being stimulating entrepreneurship by rewarding entrepreneurs for the risks that they take.
Without rewards (higher income) entrepreneurs may lack incentives to create and launch new
products and services. If the government promotes entrepreneurship, demand for skilled
workers should increase, leading to higher income for them as well. Basically, entrepreneurs
should play a bigger role in the society, which can only be beneficial for the country and its
population. However, to achieve the goal, education must also be adapted to the needs of the
economy and the required skills of labour.

Inefficiency taxation

A solution promoted by many governments to the issue of inequality is taxation and, in

particular, the efficiency of taxation (ie. solving the problem without creating a new one).
According to the left-wing politicians, a higher taxation on wealthy Americans is the key to
reduce inequality. They want to use government taxation to balance incomes, moving wealth
from the rich to the poor through education, social services, benefits, etc. To illustrate this

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with an example from another country, France, Francois Holland, Socialist President from
2012 to 2017, imposed a “wealth” taxation of 75% on income exceeding €1 million when he
was elected. During the following months, many wealthy French citizens, such as Bernard
Arnault (CEO of LVMH) and Gérard Depardieu (actor), left France seeking residency or dual
nationality in less-taxed countries. This example proves the point that such a tax hike on the
wealthy was quite inefficient given the mobility freedom of individuials. According Mankiw,
a higher taxation on wealthy is not the solution to the problem of inequality. Doing so, will
push the rich to leave the US and seek refuge in other countries to the detriment of the US
economy.

Deadweight loss

Another consequence of inefficiency taxation is deadweight loss. According to Marshall’s

analysis (1890), the deadweight loss of taxation is the measurement of how far taxes reduce
the standard of living of the population. As many liberal economists, Marshall claims that
government taxation distorts the free market which makes these taxes inefficient. To illustrate
their point, imagine a car market where the government imposes a quantity tax on new cars
sold. As reflected in the Figure 5. below, we can see a deadweight loss and the fact that
people will end up buying less new cars, which shows that the taxation is inefficient, and the
tax revenues will be lower than expected. Globally, on the one side, deadweight loss
encourages tax evasion instead of investments in the economy, working more or taking risks.
On the other side, it will drift the US economy towards lightly taxed activities, which is not
the goal of government taxation.

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Figure 5. Tax revenue and deadweight loss

Source: Own research

Causes of inequalities

According to left-wing politicians, the biggest cause of inequality is linked to rent-seeking by

the wealthy with the complicity of the government. Left-wing politicians see the rising
income of the wealthiest as a result of government’s favours such as monopoly power, lax
regulations and less trading restrictions. According to Stiglitz (2012) and Mankiw (2013), the
left-wing overlook some important aspects the contribution of the wealthiest to the economy.
Indeed, it would seem normal that someone who develops technology or starts a new
successful business, ie. an entrepreneur is likely to see his income rise. Delivering a new
product on the market that provides society with a clear benefit will create inequalities, which
is unavoidable but essential.

Secondly, following Goldin and Katz (2008), technological advances since the seventies
caused rising inequalities. In a world of technological advances and scientific progress,
demand for skilled labour has increased sharply. This trend has left less-skilled labour on the
side-lines, even more with the recent globalization. According to Ricardo (2012),
globalization is good for both poor and rich countries. “A country has to export what it is

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efficient to produce”, said Ricardo. This theory was proven and better known as
“comparative advantages”. According to this, developing countries are encouraged to
produce products requiring low-skilled labour and, conversely, developed countries should
strive to produce goods and services requiring highly-skilled labour. In this context, poorer
countries should experience rising production and, hence, employment, reducing inequalities
by improving the purchasing power and the living conditions of a large part of the population.
For Maskin (2011), “matching” is key to efficient globalization. Actually, matching unskilled
workers and skilled ones may raise productivity in a given country. Unfortunately, in the
long-term, globalization can increase inequalities. Indeed, a high-skilled worker in a
developing country is likely to immigrate to a rich country with an economy adapted to
his/her skills. In that case, the concentration of low-skilled workers in that country will be too
high, which negatively impacts productivity. Ricardo’s theory has, therefore, some limits as
globalization can decrease inequalities but only in the short-term; the impact over the long-
term seems to be negative.

The third cause is the “inequality of opportunity”. According to Stiglitz (2012), inequalities
can be driven by genetics. ‘’If America were really a land of opportunity, the life chances of
success of someone born to a poor or less educated family would be the same as those of
someone born to a rich”, he said. Sadly, incomes are closely related to those of our parents, in
most of the cases. It may seem that smart parents often have smart children. However, it
would be unwise to say that IQ is hereditary. IQ is based on talent and skills, but it represents
a standardized way to calculate human intelligence. As demonstrated by Stiglitz’s research,
human intelligence is also determined by factors such as self-control, creativity and
compassion, which are unlikely to be genetic. Hence, the theory has its debatable. According
to Sacerdote (2007), if income is not related to family, there is a link to the one’s social
environment. Sacerdote studies show that 56% of income can be explained by non-family
factors, against 33% by genetics and 11% by the family environment (linked to graph 5). In
conclusion, if income is not genetically related, there are likely to be defined in part by
social-environment factors.

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Figure 6. Factors influencing income according to Sacerdote (2007)

Family factors
11%

Genetic Non-family factors

33% 56%

Source: "How Large Are the Effects from Changes in Family Environment? A Study of Korean American
Adoptees." Quarterly. Journal of Economics 122 (1): 119-1

Solutions

Taxation (of the rich) and increasing the “utility” of the poor, as well as a combination of
both, are the main tools used today to reduce inequality.

As stated by Mirrlees (1971) one of the main solutions to reduce inequality is to find the
optimal income tax. But, according to him, when the government taxes goods and services,
only producers are affected by such taxes. Sharing the burden of taxation between sellers and
consumers could be more appropriate to decrease inequalities.

According to Mankiw (2013), inequalities can also be observed internationally or among

regions in a country. For example, in US, government can allocate aid for a region using
income from another one. It is the case between Florida and Michigan where tax revenues
from Florida are channelled to Michigan, a state suffering from weaker economic metrics.
Likewise, some economists have suggested to increase foreign countries aids to decrease
inequalities. According to Mankiw’s research, no country has proposed marginal tax rates
such as an income-based taxation between countries. Individually, it is not a solution but at
the national level it can pay off. Hence, this may also be a solution between countries.

Taxation is not the only solution to remove inequalities. Indeed, many economists agree that
the rich earn higher incomes because they contribute more to society. Instead of sharing their
income with the less-productive members of the society, Mankiw suggests tackling the

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problem the other way around, by acting upon the less productive citizens. This can be done
by increasing their utility/productivity within the society. In that way, inequalities can be
resolved over the long-term, making less-productive people more useful for the society and
incentivising them to earn more. Without this, allocating “free” aid to less-productive people,
will not encourage them to change their lifestyle or working habits. Even worse, this policy
could cause the most productive members to work less or seek refuge in less fiscally
obstructive countries.

Conclusion

The subject is vast and multidisciplinary, combining many fields of social sciences such as
economy, society and politics. One’s perception of the inconveniences and benefits of
inequality is closely linked to their political views. A left-wing equalitarian will view
inequality as a demon which needs to be eradicated, while a right-wing capitalist will
perceive the subject as an unavoidable side-effect of growth and progress. My view is that
income inequality is an unfortunate, but true reflection of society in the sense that we are all
born human beings, but with different personalities, different qualities, strengths and
weaknesses and even different mental and physical capacities. Hence, we are born unequal,
which could suggest that inequality is a natural outcome. For me a totally equalitarian world
is utopia, as progress is indeed driven by innovation, which is the fruit of science and
entrepreneurship. To stimulate the latter, incentives and rewards need to be offered to those
that work hard, take risks, etc. That said, I am of the opinion that society, through the action
of politics, should attempt to attenuate the effect of income inequality by giving every human
being an equal chance particularly through education, financed by public money. This public
money should stem from smart taxation to which the wealthy contribute more than the others.
We need to reduce the gap between the rich and the poor through a win-win mechanism
whereby entrepreneurs and risk-takers remain highly incentivized and where the less
fortunate have the opportunity but also the incentive to participate in progress.

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References

Academic papers:

1) Hillebrand, E. (2009). Poverty, Growth, and Inequality over the Next 50 Years. FAO,
United Nations – Economic and Social Development Department.

2) Mankiw, N. G. (2013). Defending the one percent. Journal of Economic Perspectives,

27(3), 21-34.
3) Ricardo, D. (2012). Principles of Political Economy and Taxation. Dover
Publications.
4) Sacerdote, B. (2007). How Large Are the Effects from Changes in Family
Environment? A Study of Korean American Adoptees. Quarterly. Journal of
Economics, 122 (1): 119-1
5) Stiglitz, J. (2013). Inequality is Holding Back. The Great Divide, The Opinion Pages,
the New York Times.

6) Wilkinson, R. and Pickett, K. (2011). The spirit level. New York: Bloomsbury Press.

Non-academic sources:

1) Equalitytrust.org.uk. (2018). The Equality Trust | Working to improve the quality of

life in the UK by reducing economic inequality. [online] Available at:
https://www.equalitytrust.org.uk/ [Accessed 9 Dec. 2018].
2) Investopedia. (2018). Deadweight Loss Of Taxation. [online] Available at:
https://www.investopedia.com/terms/d/deadweight-loss-of-taxation.asp [Accessed 9
Dec. 2018].
3) lesechos.fr. (2018). Chronologie de la taxe à 75 % sur les très hauts revenus, avant
disparition. [Chronology of the tax at 75% on the very high income, before
disappearance]. [online] Available at:
https://www.lesechos.fr/03/01/2015/lesechos.fr/0204052314589_chronologie-de-la-
taxe-a-75---sur-les-tres-hauts-revenus--avant-disparition.htm [Accessed 9 Dec. 2018].
4) Oecd.org. (2018). OCDE - OCDE. [online] Available at:
http://www.oecd.org/fr/index.htm [Accessed 9 Dec. 2018].

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5) Planetoscope.com. (2018). Planetoscope - Statistiques : Homicides commis dans le

monde. [Planetoscope - Statistics: Killed in the world]. [online] Available at:
https://www.planetoscope.com/mortalite/1200-homicides-commis-dans-le-
monde.html [Accessed 9 Dec. 2018].

List of graphs

Figure 1. Historical US GDP from 1820 to 2010................................................................4

Figure 2. World Gini estimates............................................................................................4
Figure 3. Health and social problems are not related to average income in rich countries. 5
Figure 4. Health and social problems are worse in more unequal countries.......................5
Figure 5. Tax revenue and deadweight loss........................................................................7
Figure 6. Factors influencing income according to Sacerdote (2007).................................9

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