Okun offers a neat hypothetical to help locate one’s equity-efficiency boundary. He wrote this in 1975, so all dollar amounts are far below what would make sense today. They’re 1974 dollars. In brackets, I’ve inflated them to 2009 dollars (a dollar in 1974 is worth $4.30 today). This is not the same things as recomputing the boundaries and average incomes of the bottom 20 percent and top 5 percent of the income distribution. Still, I think the exercise is worth considering.
[C]onsider the American families who make up the bottom 20 percent of the income distribution. Their after-tax incomes in 1974 were less than $7,000 [$30,100], averaging about $5,000 [$21,500]. Now consider the top 5 percent of families in the income pyramid; they had after-tax incomes ranging upward from about $28,000 [$120,400], and averaging about $45,000 [$193,500]. A proposal is made to levy an added tax averaging $4,000 [$17,200] (about 9 percent) on the income of the affluent families in an effort to aid the low-income families. Since the low-income group I selected has four times as many families as the affluent group, that should, in principle, finance a $1,000 [$4,300] grant for the average low-income family. However, the program has an unsolved technological problem: the money must be carried from the rich to the poor in a leaky bucket. Some of it will simply disappear in transit, so the poor will not receive all the money that is taken from the rich. The average poor family will get less than $1,000 [$4,300], while the average rich family gives up $4,000 [$17,200]. […]
I want you to decide how much leakage you would accept and still support [this plan]. Suppose 10 percent leaks out; that would leave $900 [$3,870] for the average poor family instead of the potential $1,000 [$4,300]. Should society still make the switch? If 50 percent leaks out? 75 percent? […] Where would you draw the line? Your answer cannot be right or wrong. […]
Of course, the leak represents an inefficiency. The inefficiencies of real-world redistribution include the adverse effects on the economic incentives of the rich and the poor, and the administrative costs of tax-collection and transfer programs.
A more stark thought experiment trading equity and efficiency is hard to imagine. Think about it. (Okun says he’d accept up to 60 percent leakage.)
