Tuesday, May 08, 2007

Becker and Murphy on Inequality

Gary Becker and Kevin Murphy, two of the most prominent members of the economics profession, tell us about the Upside of Income Inequality. An excerpt:

This brings us to our punch line. Should an increase in earnings inequality due primarily to higher rates of return on education and other skills be considered a favorable rather than an unfavor­able development? We think so. Higher rates of return on capital are a sign of greater productivity in the economy, and that inference is fully applica­ble to human capital as well as to physical capital. The initial impact of higher returns to human cap­ital is wider inequality in earnings (the same as the initial effect of higher returns on physical capital), but that impact becomes more muted and may be reversed over time as young men and women invest more in their human capital....

For many, the solution to an increase in inequality is to make the tax structure more progressive—raise taxes on high-income households and reduce taxes on low-income households. While this may sound sensible, it is not. Would these same indi­viduals advocate a tax on going to college and a subsidy for dropping out of high school in response to the increased importance of education? We think not. Yet shifting the tax structure has exactly this effect.