The Inequality We Should Worry About

It seems every day a new report warns us of the dangers of rising inequality. We are told a widening wealth gap will ultimately mean fewer economic opportunities and more corruption in our political system. The answer, according to many, is a dramatic increase in taxes on the rich. 

But before we make significant policy changes, we should ask whether the inequality we observe is good or bad. 

That might sound peculiar. After all, isn’t all inequality bad? 

Let’s consider two figures of twentieth-century American history.

In the early 1940s, a Texas Congressman defended the budget of the Federal Communications Commission. In return for his support, an FCC official suggested the politician have his wife apply for a license for a radio station in the underserved Austin market. She did so and within a few weeks, the FCC granted her permission to buy the license from the current owners. She then applied for permission to increase its time of operation from daylight-hours-only to 24 hours a day and at a much better part of the AM spectrum—and, again, the FCC granted her permission within a few weeks. The commission also prevented competitors from entering the Austin market.

That congressman was Lyndon Johnson. The FCC’s special favors made him and his wife very rich. By the time he ran for President in 1964, the radio station accounted for over half of his and his wife’s $14-million net worth. 

The second man is Robert McCulloch. He became prominent in the late 1940s, when he invented a light one-man chainsaw that made him quite rich. So rich in fact that he famously bought the London Bridge and had it shipped to Arizona. McCulloch’s success increased the gap in wealth between him and the non-wealthy, but his customers also benefited from a new tool that made their lives much easier.

The moral difference between Robert McCulloch’s wealth and Lyndon Johnson’s wealth couldn’t be clearer. By using his government connections, Johnson became quite wealthy, but at the expense of consumers who were left with fewer options for radio stations. McCulloch’s wealth, in contrast, was a byproduct of an invention that benefited many. 

Of course, neither story is unique. There are still those who benefit by seeking special government favors at society’s expense. But, more importantly, there are thousands of entrepreneurs. Each one’s success increases wealth inequality, but also improves the well-being of tens of millions of people. And, as other competitors enter the market, they drive down prices and make consumers even better off. Indeed, Yale University economist and Nobel Prize winner William D. Nordhaus has estimated that only 2.2 percent of the gains from innovation are captured by the innovators. The rest goes to consumers.

In short, there is indeed a distinction between good and bad inequality. Entrepreneurial innovation that improves the lives of consumers is good; using political muscle to become wealthy is bad. 

Government policies that fail to distinguish between good and bad inequality will reduce innovation, weaken the economy, and ultimately give people more reason to seek special favors from the government.