So, far I’ve argued that the inequality of incomes in our society is largely a matter of luck rather than inherent personal ability, and that it is only distantly related to the social value of the contributions people make through their work. These conclusions undercut the idea that taxing those on high incomes will harm society by reducing incentives to work for the most able and social valuable workers. Although the evidence was already strong, the pandemic has brought these points into even brighter relief.
Now I want to consider the claim that we need inequality in order to encourage people to take risks. The simplest response is to point to the empirical fact that high income earners take (or, more accurately, are subject to) less risk than average not more.
Hardy and Ziliak (confirmed in general terms by many other sources) give the numbers https://onlinelibrary.wiley.com/doi/full/10.1111/ecin.12044?casa_token=2_dvANjFw2EAAAAA%3AiKxuB6Tn34GJBIOZlN9Hs55w9MxJlkgR0Ns1z-1UAPIosDi2G8Yq3WF9hjUTVy8HQb95t9DwLzCRel8vyg
in any given year since 1996 the level of volatility among the bottom 10% was 81% higher than the volatility among the top 1%, and this level nearly doubled since 1981
Here’s a graph illustrating this point.
This graph shows that those at the bottom of the income distribution experience higher variance than anyone else. But using the variance as a measure understates the problem, since what matters most in an assessment of risk is the discretionary income remaining after unavoidable commitments have been met.
The statistics confirm what anecdotal evidence tells us every day: once someone has made it to the top of the income distribution, they will never become poor as a result of bad luck or business mistakes. Failed business owners wash their debts away with bankruptcy and return to the scene only marginally diminished. Failed CEOs are given multi-million dollar parachutes to soften their fall. Even personal bankruptcy isn’t commonly a problem: careful use of homeowner exemptions, irrevocable trusts and well-timed (but not too obviously well-timed) gifts can allow a bankrupt 1 percenter to live far better than a solvent member of the (shrinking) middle class, let alone a poor person.
If anything, our institutions encourage too much risk-taking at both ends of the income distribution. The rich can take risks secure in the knowledge that (with the current tax system) they will keep most of the benefits of bets that payoff while shifting most of the losses from unsuccessful bets to others. The poor take more voluntary risks because any chance of escaping the bottom of the distribution in a highly unequal society is worth a shot. And freely chosen risks seem less worrying when you are subject to so much risk that is out of your control anyway.
As usual, the pandemic illustrates this point in spades. Throughout his career, Donald Trump has relied on his ability to cash in his (relatively rare) winning bets while shifting the losses onto others. Now having gambled with his own safety and that of anyone who listens to him, he is guaranteed the best medical care money can buy, while thousands of less fortunate victims of the pandemic die every week.
fn1. The idea of the top 1 per cent as entrepreneurial risk-takers is part of a complex of spurious factoids, including ‘executive stress’ and the idea that this stress in turn causes ulcers.