For decades, our media have bombarded us with income pie charts and bar graphs, showing the share of the nation’s annual income that is said to be distributed to various economic groups (labor, landlords, and so forth). The size of each slice represents total income attributed to individuals in that group.
These charts are dangerous. By making comparisons of slice sizes over time, authors attempt to draw inferences as to the fairness of each group’s share. But this effort obscures, misleads and distorts the true process by which income is really produced and earned.
TO BEGIN, IN this context there are severe semantic obstacles with the use of the word “distribute,” or “distribution.” While defined by my Webster’s Dictionary as an apportionment, a sharing, a dispensing; earned income (which is obtained by personal sacrifice), however, is never apportioned or shared, and hence, never distributed. Unless obtained by illegal means, it is earned.
The words “apportionment” and “sharing,” however, can leave the reader with the connotation of a receipt unrelated to effort or hard work, such as a windfall. A pie chart, simply stated, may express labor’s earned income in absolute terms, or as a percent of society’s total earned income. Either expression is clear, precise and sufficient. It is not only redundant to require that these earnings be apportioned or distributed when they have been already earned, but mischievous as well. Labor’s portion of the nation’s income is not “shared” – it is earned.
The apportionment concept marks only the beginning of our semantic difficulties. The income-sharing analogy also tacitly assumes that the size of the pie is given, that it figuratively fell from heaven and is now resting comfortably on a windowsill, cooling, waiting to be sliced and “distributed” to society’s claimants. But the causal connection is just the reverse!
As shown below, this relationship involves productive agents first producing income, and then simultaneously being rewarded! The income sharing analogy, unfortunately, is most misleading and masks the fundamental role that incentives play in the income-productive processes.
The verb “to share” is particularly troublesome. “To share” literally embraces the acts of giving, allocating and earning. But labor income consists of wages and salaries. This income cannot be shared or received as gifts. It is earned. A correct statement would be that labor’s slice, for example, is the proportion of the nation’s total income contributed by wages and salaries. Occasionally, journalists say exactly that.
In our free-choice society, millions of us freely contract with one another to exchange products or services for agreed upon rewards. This provides incentives for work, for savings to be made and provided to entrepreneurs, for land and buildings to be rented, literally to provide the “blood, sweat and tears” for producing, in the first place, the total pie.
ONLY WHEN THESE millions of contracts are performed do individuals receive an earned income! Instead of being a fortuitous gift, the size of the pie is bound inextricably with the manner in which it is produced. This involves masses of individual contracts of production, which reflect rewards for incentives and work. But the underlying income-producing process determines who is rewarded and the size of the pie, which is generated by the totality of these freely negotiated contracts.
This fact is frequently overlooked by income redistributionists who start with the premise that the size of the pie is given; all we need do is redistribute it. Naïve, yes, but a view widely shared by politicians and members of the chattering classes.
Unfortunately, erroneous interpretations do not end here. They extend into many areas where the reader easily forgets that income earned is firmly tied to output contracts. For example, since incomes above ours are easily viewed as windfalls, it only takes a glance at a bar graph of income earned by groups to carelessly infer that income can be transferred by legislative decree without impairing its production or its size.
Of course, this overlooks that the existing level of income is fundamentally bound with the millions of contracts that produced it. Tinkering with freely negotiated contracts to redistribute income, including the popular pastime of imposing higher and higher taxes on high incomes might make some feel better but, because it ignores incentive effects, it incurs the great risk of reducing the size of the subsequent pie.
Reinforcing the windfall misconception is the widespread view that interest, dividends and rents are unearned income. Savings, which enable us to earn interest and dividends and provide for our retirements, represent current sacrificed consumption opportunities, which are not pleasant experiences. Hence, interest, rents and dividends are generated by personal sacrifices – in short, they are earned income. Further, it does not help clarify matters when politicians, the media and especially the IRS regularly refer to dividends, rents and interest as unearned income.
IN SUM, INCOME pie charts and their close cousins, income bar graphs, are misleading devices. By referring to them as representing income distributions, they create unnecessary semantic obfuscation. They are not apportionments of income to members of participant groups. Instead, they are rewards earned by individuals in these groups for worthwhile contractual performance. Their performance and rewards help determine the size of the pie.
The notions of apportionment and sharing carry the unfortunate connotation that somehow, total income falls from heaven, preceding its allocation, rather than being a product of incentives, rewards, hard work, and careful risk-taking by industrious citizens. Therefore, it is easy to infer that individual incomes, especially of the wealthy, may be taxed with impunity without impairing incentives to the productive process.
Preposterous, of course, but an easily discernible conclusion from the words “distribution” and “sharing.”
(The writer is a professor emeritus of financial economics at the University of Georgia. He lives in Aiken, S.C.)