How Redistribution Increases Inequality

Redistribution can often be a self-goal, and harm the poor instead of helping them.

Every year Oxfam publishes a paper which highlights the “growing inequality” between the rich and the poor, and recommends that governments should impose higher taxes on the rich, and help the poor through welfare schemes. This year has been no different.

So far, critics have attacked Oxfam’s methodology, and said that as long as poverty is declining around the world, inequality does not matter too much. But let us put all those objections aside for a moment. Suppose inequality is inherently problematic, and Oxfam’s findings are beyond reproach.

We must then ask a more pertinent question. Is redistribution the best way to fight inequality? I say no. On the contrary, it often increases inequality. That is, instead of transferring wealth from the rich to the poor, governments do exactly the opposite.

India’s Farm Policies

The government has instituted various welfare schemes in the name of helping poor farmers. Chief among these is the Minimum Support Price (MSP) scheme. If the price of certain crops falls below a pre-specified amount in the open market, as it often does, government buys the entire crop from farmers at a higher price.

Note that the amount each farmer gets is proportional to the amount of crop he sells to the government. That, in turn, depends on the size of his farm. The richest farmer, who owns the largest plot of land, grows the largest amount of produce, and receives the maximum government aid. Meanwhile, the poor subsistence farmer, who has a tiny plot of land, sells little produce and gets very little aid.

And it gets worse. Because the subsistence farmer grows crops not only for sale, but also for his own household consumption, his share of the aid is even smaller than it would initially appear. Suppose a rich farmer has 100 hectares of land and a poor farmer has only 1 hectare. The poor farmer stores half his crop for household consumption, and sells the rest, while the rich farmer can sell almost his entire crop. In this scenario, the rich farmer gets 200 times the aid that a poor farmer receives. And the poor farmhands, who have no land of their own, get nothing.

Moreover, the wealthy farmers who receive the maximum aid pay zero taxes on their income, since agricultural income is exempt from tax. Meanwhile, many struggling city dwellers who might be making only ₹3-4 lakh a year have to pay tax, part of which goes to the rich farmers.

Subsidised Mansions

Such atrocities are by no means unique to India, and are prevalent around the world. Consider zoning laws in America, which subsidise mansions for the rich at the expense of the poor.

In Atherton, California, for example, building codes dictate that on lots of 1 acre or more, only single dwelling units may be built, with a floor area ratio not exceeding 18%.

In the absence of such regulation, a developer might pay hundreds of millions of dollars for one such lot, and build a high rise apartment building on it having hundreds of dwelling units. The developer would make a profit even if they sold each apartment at an affordable price.

But because they are not allowed build those apartments, they don’t bid for the land, driving down its price. Now a rich person who wants to build a mansion there can buy it for far cheaper than they could have otherwise. Government has effectively subsidised mansions for the rich while lower income people struggle to find housing. Although Atherton is an extreme case, similar instances can be found in other expensive cities such as San Francisco as well.

Minimum Wage Laws

Minimum wage laws are often touted as helping the poor workers. But if we look at who lobbies for such laws, we find something interesting. Take the instance of the US government imposing a minimum salary requirement for hiring migrant workers who arrive on H1B visas.

Two groups are unlikely allies in supporting such legislation. The first is labour unions, who can bargain for higher salaries if they don’t have to compete with cheaper workers from India or China, even though the union members already make far more than the specified minimum salary.

The second is large corporations such as Microsoft and Facebook. Why? Because although it would raise their labour costs, it would also raise the costs for smaller firms which compete with them. The large corporations can absorb higher costs, while the smaller firms are more likely to go out of business.

Bailouts and Other Scandals

Many economists have criticised the Export-Import Bank of the United States for its crony capitalism. The bank was initially advertised as a way for small firms to secure funding for their exports. Yet a lot of the loans go, either directly or indirectly, to multi-billion dollar corporations such as Boeing, General Electric and SpaceX among others.

And of course I must mention schemes such as TARP (essentially bailing out large financial institutions with tax money) and bailouts for large automobile companies such as General Motors and Chrysler, which made rich people richer.

Another example is occupational licensing laws around the world. People such as lawyers and accountants, who are already well paid, are protected against competition by such licensing laws, which allows them to charge more for their services. Milton Friedman once complained about many people and firms in the US having made millions by selling or renting out trucking licences, even though they didn’t own any trucks and would never use the licences themselves.

A Bug or a Feature?

It is not the case that such injustices are unintended consequences which no one could have foreseen. Rather, they are built into any political system as a result of human nature. Writing way back in 1848, economist Frederic Bastiat predicted the consequences of a redistributive welfare state as follows:

Finally, we shall see the entire people transformed into petitioners. Landed property, agriculture, industry, commerce, shipping companies, industrial companies, all will bestir themselves to claim favours from the state… Everyone’s effort will be directed toward snatching a scrap of fraternal privilege from the legislature. The suffering classes, although having the greatest claim, will not always have the greatest success.

Clearly, as we saw through all these examples, the rich have captured “fraternal privilege” at the expense of the poor. Those who truly wish to reduce inequality and help poor people would be wise to heed Bastiat’s words.

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About the author

Jairaj Devadiga

Jairaj Devadiga is an economist. His work mainly deals with public policy and economic history. His writings have been published by various think tanks such as the Foundation for Economic Education, the Centre for Policy Studies and the Institute of Economic Affairs.