Defending the One Percent

I imagine a society with perfect economic equality. Perhaps out of sheer coincidence, the supply and demand for different types of labor happen to produce an equilibrium in which everyone earns exactly the same income. As a result,no one worries about the gap between the rich and poor, and no one debates to what extent public policy should make income redistribution a priority. Because people earn the value of their marginal product, everyone has the appropriate incentive to provide the efficient amount of effort. The government is still needed to provide public goods, such as national defense, but those are financed with a lump-sum tax. There is no need for taxes that would distort incentives, such as an income tax, because they would be strictly worse for everyone. The society enjoys not only perfect equality but also perfect efficiency.

Then, one day, this egalitarian utopia is disturbed by an entrepreneur with an idea for a new product. Think of the entrepreneur as Steve Jobs as he develops the iPod, J. K. Rowling as she writes her Harry Potter books, or Steven Spielberg as he directs his blockbuster movies. When the entrepreneur’s product is introduced, everyone in society wants to buy it. They each part with, say, $100. The transaction is a voluntary exchange, so it must make both the buyer and the seller better off. But because there are many buyers and only one seller, the distribution of economic well-being is now vastly unequal. The new product makes the entrepreneur much richer than everyone else.

The society now faces a new set of questions: How should the entrepreneurial disturbance in this formerly egalitarian outcome alter public policy? Should public policy remain the same, because the situation was initially acceptable and the entrepreneur improved it for everyone? Or should government policymakers deplore the resulting inequality and use their powers to tax and transfer to spread the gains more equally?

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