The Tradeoff

The Tradeoff

There is a governing principle in economics called the “Equality-Efficiency Tradeoff.” It basically states that a society’s efforts to make the incomes of its citizens more equal, will inherit the adverse affects of a decrease in efficiency (or productivity) from those citizens. Why would a society need to make an effort to make the incomes of its citizens more equal? Well, because they are unequal (or inequal) to begin with, of course. Why are they unequal? That is a great place to begin our discussion.

In a predominantly free-market capitalistic economic system, such as the United States has, the major reason incomes are unequal is that this system rewards its citizens based on their abilities. The pre-amble to our Constitution states that “all men are created equal”, but equal does not mean same. We all have different abilities; things we do well, and things we don’t do so well. Our society rewards its citizens based on the satisfaction that buyers receive (economist call this “utility”) when they pay to enjoy our abilities.

Allow me a personal illustration. Let me tell you about two people that I admire. The first is my wife. Kelly works for an organization called “Pre-School Partners”, affectionately referred to as PSP. It’s a non-profit organization that targets 3 and 4 year old children from inner-city Birmingham. Many of these kids are from low-income, single parent homes, and this program is designed to prepare them for kindergarten. The program is extremely affordable, yet the parents are required to take classes also, in things like time management, anger management, and money management. Sound like a program that is making a positive impact on the demographic it was intended to serve? Statistics say so. Five years after leaving the program, PSP kids have higher grades and better attendance records than their counterparts who did not complete the program. Do you think Kelly’s work makes a valuable contribution to society? I think so.

The second person I’ll tell you about is a guy named Peyton Manning. You may have heard of him. He’s won the NFL’s Most Valuable Player Award an unprecedented four times. His last contract to play the game of football was reportedly in the neighborhood of $69 million over 3 years. Let me pause here to say that Kelly makes significantly less than that. Why? Is it because her contributions to the well being and functionality of our society are significantly less than Peyton’s? No. It’s because no one has ever lined up to pay $150 each to watch Kelly teach letters and numbers.

Now we can argue that society should value its teachers (and police officers, and paramedics, and firefighters, and so on) over its athletes, but do we? I once heard someone say, “You show me your calendar and your bank statement, and I’ll show you what’s important to you.” The things we spend time and money on are the things that are truly important to us. And our society values entertainment. Many people are willing to pay their hard earned money to watch Peyton execute his abilities, where they are not willing to do so for Kelly’s.

Is this fair? I have three thoughts in response to this question.

First, life is not fair. Anyone who tells you otherwise is selling something. We are imperfect people, living in an imperfect world, and because of that, life will never be perfect.

Second, and this is the principle most fail to comprehend, Peyton’s ability to make $23 million a year, doesn’t decrease Kelly’s opportunity to make that much. Wealth is not like a great big pie that, when divided, means that if you get a bigger slice, I, by definition, get a smaller one. Wealth creates more wealth. Peyton making big money means that someone has to build a big stadium for him to play in, and someone has to make jerseys with his name and number on them (for him and thousands of fans), and someone has to make hot dogs that sell for $15 at that stadium on the days he’s wearing that jersey, and executing his abilities.

Third, and lastly, I would ask anyone who asks “Is this system fair?” to explain to me another system that has historically set a precedent for greater fairness.

Now, if we have a system that creates so much inequality, (and we do) and we begin to value equality (which we have), what steps could we take to ensure more income equality? Two things could accomplish this; a progressive tax structure and transfer payments.

A progressive tax is taxing a higher fraction of a higher income. A progressive tax bracket structure takes more money away from rich people, which by definition makes them poorer. Transfer payments then take some of that money and give it to poorer people (in the form of Social Security, and food stamps, and earned income tax credits), which by definition makes them richer. That’s how you bring about greater income equality.

There is a negative unintended side affect to these practices is that it gives both groups less incentive to be productive. In fact, it gives both groups more incentive to be less productive; less efficient. As a rich person, why would you work hard to make more, if the reward would be that more would be taken? As a poor person, why would you work hard to make more, if the reward would be that less would be given? (Incidentally, if you do not believe that most people are driven by individual ambition and incentive, I would love for you to introduce to me these angels among us.)

Allow me a second personal illustration. I was born with the condition cerebral palsy, commonly known as CP. It’s a little like a short circuit in the wiring between my brain and muscles. CP has severely affected my balance and coordination , and I use an electric wheelchair for mobility. Simple things like getting dressed, or loading into a vehicle, or picking up a pen I’ve dropped, are challenging at best. According the laws of our land, I am fully qualified to receive a Supplemental Security Income (SSI) check (commonly known as disability) from the federal government each month.

However, at some point I decided that I wanted more out of life. In high school I studied and made good grades and did well on the ACT. I earned scholarships to college, and studied, and made good grades. I am now a gainfully employed, productive, tax-paying member of society. I teach economics at a college.

One day, during a break between semesters, I decided to go fishing. While fishing off the dock, I noticed a car pull into the parking lot. The driver, a guy who appeared to be about my age, hopped out of the car and seemed to have no trouble carrying a large bag of charcoal. He made another trip from his car to the picnic table, this time carrying coolers and other odds and ends. On his third trip, he gathered his tackle box and rod and reels, and headed my way.

We chatted for awhile, while we fished, as fisherman often do. During the course of our conversation I asked, “What do you do?” He said, “Oh, I, uh…draw a disability check.” Now I’m as friendly as the next guy, and we continued to talk and fish for quite some time.

But sometime later I realized something. Every day the alarm goes off, I struggle with the challenge to get out of bed. I struggle with the challenge of getting dressed. I struggle with the challenge of getting into my vehicle, sometimes with the added challenge of buckling my children into their car-seats when I’m in charge of day care. On the job, I work to adequately perform the required duties of my position.

And I do all of this so that (among other things), on occasion I may enjoy some leisure time – like fishing. I also realized that, meanwhile I am receiving another reward for my diligence, good choices, and hard work. I get to pay taxes! And some of those taxes go to pay the disability check of my fishing buddy!

Now let me ask you a question: If someone had explained to me during my formative years that this is the way things would be, do you think it would have provided me any incentive to press forward? Do you think, if someone had told me that this is the way the world works, that I would have been more motivated to set goals or try to achieve more in life? I don’t. In fact, I might have been persuaded to take advantage of the hand-outs being offered. It would have certainly been easier.

This is the “Equality-Efficiency Tradeoff.” And it gives both groups less incentive. It gives “rich people” less incentive, for they know the more they work, the more will be taken. It gives “poor people” less incentive, for they know the less they work, the more will be given.

In 1990, in his book “Free to Choose”, Milton Friedman said, “A society that puts equality before freedom will get neither.” It seems that twenty years later, we still haven’t heeded this warning.