Income Inequality and Education

George Rebane

[This is adapted from a 3jun07 posting to RR when it resided on The Union website.]

You earn more money the more education you have.  This astounding conclusion was recently reported in the May/June 2007 issue of The American by two leading lights in economics – Nobel laureate Gary Becker and Clark Prize winner Kevin Murphy.  It is most astounding to the many Americans and our government who behave as if high earners are somehow stealing money from the low earners and must therefore be punished.  This punishment comes in the form of being constantly lambasted in the populist media and having more of their earnings confiscated by the state.

Smarter people, it seems, have the ability to find jobs that pay more or start enterprises that ultimately make them wealthy.  And whenever you combine economic freedom with increased levels of schooling in a population, you will see income inequality develop and grow.  It doesn’t take rocket science to understand that if two people, say, a high school dropout and a college graduate, start with annual wages of $25,000 and $50,000 respectively.  In ten years with 6% annual increases their initial wage disparity of $25,000 will grow to almost $45,000 at which time they will earn $44,771 and 89,542.  But in the real world the graduate will probably have additional opportunities at jobs with wage increases over the years that will average significantly higher than 6% per year.  In the meanwhile the under-educated dropout will be struggling to keep his salary increasing at 6%.

Now at least half of our citizens and government think that such a gap should be reduced by confiscating more of the graduate’s earnings through progressive taxation.  This message on punishing the fruits of education is not lost on the graduate or the dropout.  To protect the earning power of his meager and readily replaceable skills, the dropout must join with others in similar straits to seek government protection for jobs through collective bargaining that is enforced by the police powers of the state.  The dropout’s more attractive alternative is to get his belated GED certificate and get a government job that becomes a sinecure to early retirement with all benefits paid.

The graduate’s alternative is to attempt to retain her higher earning’s by paying tax accountants to discover loopholes in our unbelievable tax code and/or exposing herself to extra risk through various investments.  If she fails, she suffers her losses quietly and ignominiously.  If she succeeds, then she continues as a member of the ‘rich’ and remains under the magnifying glass of journalists and politicians as a target of further leveling policies.  This is the general process under which the educated compare their rewards to the less educated and attempt to explain to their children why it pays to stay in school.  The national dropout rates show it’s not easy to convince kids to stay in school.

Becker and Murphy’s research also shows that “the upward trend in the returns to education is not limited to one segment of the population.  Education premiums for women and African Americans have increased as much as, or more than, the premiums for all workers.”   They go on to state that “the proportion of black women who attend colleges and universities jumped from 24 to 43 percent between 1974 and 2003, while the proportion of  white men rose only from  41 to 49 percent.”  The latter is important because the data show that women gain more from a college education than men.

The bottom line from this research is that more education is the most demonstrable cause of significantly higher wages over the long haul and therefore the cause of the much decried income inequality.  Becker and Murphy’s punch line question is “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?  (They) 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 now obvious conclusion from all this is that “instead of lamenting the increased earnings gap caused by education, policymakers and the public should focus attention on how to raise the fraction of American youth who complete high school and then go on for a college education.”

But our governments at all levels have other ideas that attach the most limiting and visible anchors to the educated producers in our society.  At the federal level Becker and Murphy feel “it will be a disaster if the focus remains so much on the earnings inequality itself that Congress tries to interfere directly with this inequality rather than trying to raise the education levels of those who are now being left behind.”  What the authors of the study do not state is that our politicians pander to the simplest thought patterns of the less educated voters – ‘them that’s got more should pay them that’s got less regardless of how the more and the less got what they got’.

The only sustainable solution, short of reducing us all to a uniform level of poverty, is to encourage more investment in human capital.  The two economists end their report with the delicacy of those who might seek future government research funding, observing that “attempts to raise taxes and impose other penalties on the higher earnings that come from greater skills could (emphasis mine) greatly reduce the productivity of the world’s leading economy by discouraging investments in its most productive and precious form of capital – human capital.” 

I suppose that the next astounding results from this line of research will show that in an era of accelerating technology and globalization, imposing penalties on higher earnings that come from greater skills will indeed reduce our leading economy to a lagging economy. (see also  ‘Brain-Draining our Future’)

Comments

[Greg Zaller]

On the other hand after some google.com research I found that in the period between 1979 and 2005 the after tax income of the bottom 20% went up 6% and the top 20% went up 80%. http://www.cbpp.org/12-14-07inc.htm The bottom 20% earned an extra $900 compared to $76,500. This increase is about what the college graduate cited in the blog earns after ten years! The top twenty percent after tax income increased five times what the bottom twenty percent's earns. Regardless of education the rich are getting richer and the poor are getting poorer. Is this a sustainable way to run a tax system?

[Wayne Hullett]

Perhaps further research will reveal the the similar probablistic relationship that the harder a person works, the luckier he becomes.

[George Rebane]

Thank you for the thoughtful comment Greg Zaller. The data you cite underlines the point I am making in the post. The top percentage earners all share a strongly correlated attribute - they are more educated. And as we continue approaching the Singularity, the best educated (with wealth generating skills) will continue to outpace the poorly educated even more. You ask whether a tax policy that allows this is "sustainable" which I presume indicates that a "more progressive" tax schedule that redistributes even more wealth to those not earning it will be more sustainable. History doesn't show that. Social stability has so far been maintained by the fact that the population of the lower earning percentages is very dynamic; only a very small percentage of people in, say, the bottom 10% earning bracket stay there for very long. For almost all of us it primarily serves as the low starting rung on the climb up the economic ladder. The other fallacy that sometimes concerns folks who examine such earnings inequalities is that they think that the top earners are making it so the bottom earners can't earn more, i.e. that the high earners are taking money rightfully belonging to the low earners. This assumes that the economy is a zero sum game which it definitely is not. It is the high earners who have started the businesses and investments that grow the economy and raise the wages of all according to their abilities. Without them, we would be back to what the old USSR or China were or what is going on in North Korea and Cuba today. Even China realized that to increase the wealth of the very poorest, they had to free the smartest to start the wealth generating businesses that is now bringing China into the modern age, but not without tremendous income inequality. The same thing is beginning in Vietnam. The last thing you want to do is impose punitive transfer payments on the producers which basically leads to 'Game Over' where the lowest wage earners get hit the hardest and everyone who cannot escape the system winds up poor (except, of course, the small cadre of government elite).

Finally, in 2005 the CBO reports that the richest 1% paid over 39% of all income taxes, the richest 5% paid almost 60%, and the richest 10% paid 70%. Under Bush2 the wealthy and high earners have had the most money extracted from them. Hazlitt's 'Economics in One Lesson' explains it well. And I wouldn't bet against the probabilistic relationship that Wayne Hullett suggests. gjr

[mikey mcd]

A cumbersome tax system hurts the lower class ("poor") by way of raping the will to earn more by the wealth generators. Any CPA will tell you about wealth generators that stop hiring/stop growing because they hit a wall where it feels like each additional dollar of profit just goes to the IRS/Franchise tax board.

"In 2005 the CBO reports that... and the richest 10% paid 70%." These facts are ignored by those begging for "equality" it is the wealthy that provide for a higher standard of living for all.

[gjr] Good points mikey mcd. For more on this please visit the SESF website page on Numeracy Nuggets and take a look at NN9.

[Greg Zaller]

I ended my other comment on this topic the other day by questioning the fairness of the tax system. To what extent is it corrupted, to what extent does it discourage innovation and entrepreneurship and how could it be improved? This is a complex and weighty question with no clear agreement. How can democracy and society be sustained when such decisions are made simply by those who vote in majority and most of them without even a well founded opinion? I think the basic need of the tax system is to encourage education.

If I were to propose a single change to the tax system I wouldn’t be distracted, like so many, by who has the most right to the money. I would approach gathering funds with the intent of not unreasonably discouraging any person from increasing his contribution to the long range benefit of society. I wouldn’t spend this money on “improving” education but on changing it radically and making it feasible and pleasantly challenging for everyone. I would find a way for our schools to teach leadership, free thinking, creative problem solving as well as needed skills. This is easier said than done.

[mikey mcd]

I have a different box I think inside of. Namely, the box that asks,"Why am I taxed for education." My mother, brother, 2 sisters in law, Aunt all have teaching degrees. I would love nothing else than to have my children educated by such loving and connected (via blood) educators. No, I need to pay taxes to a government that mandates who, what, where, when my children get educated. You certainly cannot find a catalyst for the "free thinking", "creative problem solving", "leadership" goals in the traditional government mandated US education of today. Why not allow you to keep your tax dollars and me mine, and hire our own educators for our children (think little house on the pr airy school houses). Fed gov Education program is just one example of how we are taxed to have our freedoms and liberties stripped from us.