A Philosopher's Blog

Inequality & Incentives

Posted in Ethics by Michael LaBossiere on January 13, 2016

One of the stock arguments used to justify income inequality is the incentive argument. The gist is that income inequality is necessary as a motivating factor—crudely put, if people could not get (very) rich, then they would not have the incentive to do such things as work hard, innovate, invent and so on. The argument requires the assumption that hard work, innovation, inventing and so on are good; an assumption that has a certain general plausibility.

This argument does have considerable appeal. In terms of psychology, it is reasonable to make the descriptive claim that people are primarily motivated by the possibility of gain (and also glory). This view was held by Thomas Hobbes and numerous other thinkers on the grounds that it does match the observed behavior of many (but not all) people. If this view is correct, then achieving the goods of hard work, innovation, invention and so on would require income inequality.

There is, of course, the counter that some people seem to be very motivated by factors other than achieving an inequality in financial gain. Some are motivated by altruism, by a desire to improve, by curiosity, by the love of invention, by the desire to create things of beauty, to solve problems and so many other motives that do not depend on income. These sort of motivations do suggest that income inequality is not necessary as a motivating factor—at least for some people.

Since this is a matter of fact regarding human psychology, it is something that can (in theory) be settled by the right sort of empirical research. It is well worth noting that even if income inequality is necessary as a motivating factor, there remain many other concerns, such as the question of how much income inequality is necessary (and also how much is morally acceptable).

Interestingly, the incentive argument is something of a two-edged sword: while it can be used to justify income inequality, it can also be used to argue against the sort of economic inequality that exists in the United States and almost all other countries. The argument is as follows.

While worker productivity has increased significantly in the United States (and other countries) income for workers has not matched this productivity. This is a change from the past—income of workers went up more proportionally to the increase in productivity. This explains, in part, why CEO (and upper management in general) salaries have seen a significant increase relative to the income of workers: the increased productivity of the workers generates more income for the upper management than it does for the workers doing the work.

If it is assumed that gain is necessary for motivation and that inequality is justified by the results (working harder, innovating, producing and so on), then the workers should receive a greater proportion of the returns on their productivity. After all, if high executive compensation is justified on the grounds of its motivation in regards to productivity, innovation and so on, then the same principle would also apply to the workers. They, too, should receive compensation proportional to their productivity, innovation and so on. If they do not, then the incentive argument would entail that they would not have the incentive to be as productive, etc.

It could, of course, be argued, that top management earns its higher income by being primarily responsible for the increase in worker productivity—that is, the increase in worker productivity is not because of the workers but because of the leadership which is motivated by the possibility of gain on the part of the leadership. If this is the case, then the disparity would be fully justified by the incentive argument: the workers are more productive because the CEO is motivated to make them more productive so she can have even greater income.

However, if the increased productivity is due mainly to the workers, then this seems to counter the incentive argument: if workers are more productive than before with less relative compensation, then there does not seem to be that alleged critical connection between incentive and productivity required by the incentive argument. That is, if workers will increase productivity while receiving less compensation relative to their productivity, then the same would presumably hold for the top executives. While there are many other ways to warrant extreme income inequality, the incentive argument does seem to have a problem.

One possible response is to argue for important differences between the executives and workers such that executives need the incentive provided by the extreme inequality and workers are motivated sufficiently by other factors (like being able to buy food). It could also be contended that the workers are motivated by the extreme inequality as well—they would not be as productive if they did not have the (almost certainly false) belief that they will become rich.

 

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Taxing the 1% IV: Incentives

Posted in Ethics, Law, Philosophy, Politics by Michael LaBossiere on November 25, 2015

As noted in previous essays on this topic, the highest income folks in the United States now pay about 1/3 of their income in taxes.  The left has proposed increasing the tax rate to 40% or even 45% while the right has countered with proposals to either not raise taxes or cut them even more. This, the final essay in this series, considers the stock argument that a tax increase will be a destroyer of incentives.

The gist of the argument is that if the taxes for the top income brackets is increased to 40% or higher, the rich will become demotivated and this will have negative consequences. Since these negative consequences should be avoided, the conclusion is that taxes should not be increased—thus keeping the incentives in place.

In terms of assessing this argument, there are two major points of concern. One is whether or not a tax increase would destroy the incentives of the top economic class. The other deals with the negative consequences, their nature, their likelihood of occurring and the extent and scope of the harm. I will begin with the alleged consequences.

The alleged consequences are many and varied. One is based on the claim that the top economic class contains the innovators and if they are demotivated, then there will be less innovation. This could range from there being no new social media platforms to there being no new pharmaceuticals. While this is a point of concern, this assumes that innovation arrives primarily out of the top economic class—a matter that can tested empirically. While some top earners are innovators, much of the innovation seems to come from those in the lower economic classes—such as the folks in the labs doing the actual research and engineering. The idea that the rich are the innovators certainly matches the fiction of Ayn Rand, but seems to miss the way research and development actually occurs.

Another is based on the claim that the top class serve as the investors that provide the capital that enables the economy to function. Since the top class controls the capital, this is quite a reasonable concern. If Americans with the largest shares of the money decided to reduce or stop investing, then the economy would need to rely on foreign capital or what could be provided by the lower classes. Since the lower classes have far less money (by definition), they would not be able to provide the needed financial support. There are, of course, foreign investors who would happily take the place of the wealthy Americans, so the economy would probably still roll along. Especially since American investors might find the idea of losing out to foreign investors sufficient motivation to overcome the demotivation of a tax increase.

There is also the claim that the top income class contains the people who do the important things, like brain surgery and creating the new financial instruments that will take down the world economy next time around. While this does have some appeal, it seems that much of the important stuff is done by people who are not in the top classes. Again, the idea that the economic elite are doing the important stuff while the rest of the people are not (or are takers rather than makers) is yet another part of the fictional universe of Ayn Rand.

Fairness does, however, require that these matters be properly investigated. If it can be shown that the top class is as critical as its defenders claim, then my assertions can be refuted. Of course, it is well worth considering that much of the alleged importance of the top class arises from the fact that it has a disproportionate share of the wealth and that it would be far less important if the distribution were not so grotesquely imbalanced. As such, a tax increase might have the impact of decreasing the alleged importance of the top economic class. I will now turn to the matter of whether or not a tax increase would demotivate the top economic class.

One easy and obvious response to the claim that a relatively small tax increase would demotivate the top economic class is that the vast majority of the rest of us work jobs, innovate, invest and do important things for vastly less than those at the top. Even if the rich paid slightly more taxes, their incomes would still vastly exceed the rest of us. And if we can find the motivation to keep going despite the relative pittances we are paid, then the rich can also do so. When I worked a minimum wage job, I was motivated to go to work. When I was an adjunct making $16,000 a year, I was still motivated to go to work.

It could be replied that the lower classes are motivated because they need the income to survive. We need to work to buy food, medicine, shelter and so on. Those who are so well off that they do not need to work to survive, it could be claimed, also have the luxury of being demotivated by a slight decline in their income. Whereas someone who must earn her daily bread at a crushing minimum wage (or less) job has to get up and go to work, the top economic folks can allow themselves to be broken by the slight tax increase and decide to stop investing, stop innovating, and stop doing important stuff.

One reply is that it seems unlikely that the top folks are so weak as to be broken by a slight tax increase. Naturally, a crushing increase would be a different story—but there are no serious proposals to inflict crushing tax burdens on the rich. After all, crushing burdens are for the poor. Another reply is that if the current rich become demotivated, there are plenty of people who will be happy to take their place—even if it means paying slightly higher taxes on a vastly increased income. So, we would just get some new rich folks to replace the demotivated slackers—capitalism at its finest.

 

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