Question

Stephanie and Peyton are working the midnight shift at a fast-food restaurant, where they make slightly above the national minimum wage. Business is slow, and they begin discussing income inequality after a Mercedes SUV full of college-aged kids comes through the drive-thru for burgers and shakes. Stephanie believes that the growing disparity between the rich and the poor is wrong: “It’s just not fair that people like us are poor and often out of work, while millionaires and their kids are living large.” Peyton is not so sure. “Well, millionaires work hard for their money. They deserve to enjoy the fruit of their labors.” Stephanie says, “But we work hard too. I could work forever at this minimum wage job and never get ahead. Most rich people start out with an advantage, go to a good college, and then get richer. And that’s not fair.” Peyton responds, “It may not be fair, but capitalism is the only system that works, and everyone deserves a chance to get rich. Would you prefer a communist system where nobody has that chance?” Stephanie shrugs. “Maybe not communism,” she replies. “But I say we should tax the rich more heavily and use that money to reduce the burden on the poor and unemployed.” Peyton shakes his head, “Do that and you’ll ruin our country.”

Whose side are you on? Do you agree with Stephanie or with Peyton? Is there a third alternative? Explain your answer with specific concepts discussed in this chapter.

Answer 1

The given situation highlights the debate between Capitalism and Communism. This issue is a global concern, and all countries face this trade-off.

At its essence, the debate is about the trade-off between efficiency and equality.

The capitalist system encourages efficiency. Those who are able to maximize their gains from the available scarce resources, are the ones who become wealthy. Those who are inefficient, remain poor. The communist system encourages complete equality. Regardless of how hard you work, the government allocates equal income to everyone.

However, it is not entirely true that millionaires (or their children) have worked hard for their money. In today's times, there are many instances of crony capitalism as well. There are issues of corruption and rent-seeking, which have made certain sections of society wealthier. At the same time, a complete communist system is like a prison, where all your decisions are made by the government.

Peyton is correct in saying that those who work hard should get more money. Stephanie is correct in saying that she works hard, but may never get ahead. This is because she wasn't super-rich to begin with. She is also correct in saying that the rich should be taxed more heavily, and some of the revenue generated should be used for social equality.

However, historically, the presence of the Laffer curve has negated this logic. If tax rates are kept too high, the rich will find ways to evade their taxes, and overall tax revenues might actually fall. The entire premise of social welfare will fail.

On the other hand, a zero tax rate will imply there is no tax revenue, and the system is purely market-driven.

There has to be a balance between the two extremes, and a third alternative. Most countries have by now implemented the system of progressive taxation. This is different from Stephanie's system of "tax the rich heavily". This is more like a slab-based approach, where only income beyond a certain threshold will be taxed. Overall, the highest tax slab should not be very high.

Similarly, Peyton's system of "don't regulate the rich" is also wrong.

As of now, the progressive tax system is the balance that most countries have found. The other issue governments have faced globally is that of compliance. If all citizens pay their taxes, no matter how small the taxes are, a major problem is solved. This is has to be combined with transparency from the government's side, by eliminating leakages.

In many developing countries, only 5% to 10% of the citizens pay their taxes. This leads to an overall lack of funds in the system, combined with high rates of corruption. On the other hand there are wealthy businessmen who don't pay a single dollar in taxes, as most of their business is unofficial (black money).

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To sum up, it is difficult to completely take sides, as both Peyton and Stephanie have certain logical flaws. The alternative described is a good balance of the two.