Not All Inequality Is Created Equal

Rising income inequality has become the focal point of much of the economic and political discourse. Inequality-obsessed Gabriel Zucman has a new book called “We Need to Tax Billionaires”, building on the long work by himself, Saez, and Piketty on inequality. However, the inequality debate has a framing problem. Critics on the left treat rising Gini coefficients as self-evidently bad and immediately call for redistribution and even wealth taxes. Many on the right just dismiss inequality concerns entirely. As has become a focal point of my Substack lately, both sides are missing the point.

The real question isn’t whether inequality exists; it obviously does, and there’s been an uptick in the U.S. The question is what kind of inequality we are dealing with, because there actually is such a thing as “good” and “bad” inequality.

Potential Trade-Offs

Arthur Okun, in his 1975 book Equality and Efficiency: The Big Tradeoff, made a relevant point: a market-based economy that pursues productive efficiency will generate unequal outcomes. The reasoning is fairly straightforward. People differ in skills, work effort, and risk tolerance; given those differences, incomes will differ amongst individuals. There’s a reason Patrick Mahomes makes more than me. One, he’s a better quarterback than I am, and two, that skillset has been deemed more valuable in the marketplace. The same exists within the same skillsets, and people make trade-offs. Some choose to risk their savings on new ventures, while others take jobs that provide more stability, work-life balance, and more certainty in retirement pensions/savings.

While his framing is accurate, it can also treat inequality as a monolith, where it is simply the price of inequality. But the story again is more complicated.

Two Types of Inequality

In a 2017 paper, my friend Vincent Geloso and Steven Horwitz drew an important distinction. They separated what they called “good” inequality from “bad” inequality; this distinction helps explain why you cannot just simply look at inequality on its own and expect to explain societal outcomes or prescriptions from it.

Good inequalities arise from individual choices and the rewards to skill and innovation. The Patrick Mahomes example earlier explains this. Also, the fortunes accumulated by genuinely innovative entrepreneurs reflect how much value they created for everyone else. Previous estimates found that innovators “capture” a negligible amount of the value that they create for others. The entrepreneur captures a tiny slice, and the remaining surplus and value go to the rest of society. Not a bad deal for us! As Vincent and the late-Steven note, policies trying to limit this type of inequality will inevitably make society worse off.

Bad inequalities, on the other hand, arise when government policy restricts options for many, especially those at the bottom, while providing even more opportunities for those at the top. Here are some simple examples. Zoning restrictions raise housing costs and trap less skilled and younger workers (without the financial capital to afford to move there) out of high-productivity cities. Ganong and Shoag estimated that this dynamic alone explains about 10% of the rise in U.S. inequality from 1980 to 2010. Occupational licensing, an area we focus on a lot here at Archbridge, erects expensive barriers to entry into industries that the credentialed already occupy. This harms low-income people to a greater extent, given that a fixed fee is a higher percentage of their income than for someone who is already relatively well off. Corporate subsidies and lobbying for regulations on new entrants entrench wealth for the well-off and politically connected. These are the types of “bad inequalities” that are worth pursuing fixes for.

There’s also a simple measurement issue. Take a simple example. If an immigrant moves from another country to the United States, they typically make much more than they did back home (if not, why would they move in the first place). However, on average, immigrants (at least at first) make less than the average income in the United States. By definition, that increases inequality, but few would argue that this is bad for the immigrant. The immigrants’ mobility and opportunities increased. This is one of the many reasons why I prefer measuring something closer to social or income mobility, as it better captures opportunities for individuals.

Other “measurement error” issues arise from aging populations. Thomas Lemieux estimates that about 75% of the increase in inequality can be explained by aging populations. People typically earn more the further along in their career they are; if societies get older on average (people living longer, fewer kids, etc), then simply inequality measures will naturally rise. And furthermore, much of the “not-measurable” skills (networking, social capital, etc) will only further conflate that.

This framing maps well to my recent piece on billionaires. Where markets reward value creation, ambitious people build companies. Where the state controls enough resources and regulatory leverage, ambitious people capture those instead.

Good inequality is the downstream result of productive entrepreneurship rewarded in competitive markets, while bad inequality is the result of unproductive entrepreneurship rewarded by political capital. The crucial insight from Baumol is that it is a story about institutions. Productive behavior and unproductive behavior respond to incentives, but they just operate in different institutional environments.

Better Focus

This whole discussion matters for policy because misdiagnosing the source of inequality leads to the wrong prescriptions. If inequality comes from “too much productive entrepreneurship,” the cure destroys the mechanism that generated prosperity in the first place. Instead, if the problem is “too much rent-seeking and regulatory capture,” the cure is to shrink the pool of rents that are available. Cut the red tape, roll back the corporate subsidies, reform zoning, and remove occupational licensing.

The great paper from Vincent and Steven highlights this perfectly. The relevant test for an inequality is whether it benefits the least well-off, or at a minimum, “does them no harm”. For those serious about addressing opportunities, the answer likely goes beyond simple measures of inequality. Stop conflating the two types, and focus on the low-hanging fruit that is government policies that manufacture bad inequality at scale.