Wednesday, March 11, 2009

The Utility of Wealth Redistribution

How much happiness can someone receive from $100? If you are poor and that $100 is the difference between eating for a week instead of starving, then that $100 might make you very happy. A wealthier person, on the other hand, might receive utility from spending that money on a new pair of shoes. Higher levels of wealth or income are generally assumed to lead to greater utility, but there is also an assumption of diminishing marginal utility in that each additional $100 provides less and less utility. This would suggest that an additional $100 matters more to a poor person than it does to a rich person. That is the basic argument in favor of welfare – that the decine in the rich person’s utility is less than the gain in the poor person’s utility. However, there are many factors associated with utility, and it would be wrong to assume that wealth redistribution would always lead to greater total utility.

The first critique involves the fallacy of interpersonal utility comparison. Money has different effects on different people. Some people don’t care about money and prefer a minimalist, almost monastic, lifestyle. These people may smugly scoff at other people who receive great utility from their conspicuous consumption. Some people are very proud and would lose more utility from accepting a handout than they would receive from accepting that money and spending it. Other people are miserly and greedy and feel the loss of every penny. A transfer of wealth from the miserly and the greedy to the proud and monastic would reduce total utility. I think it’s fairly safe to assume that wealthy people are more likely to place a great value on money in the same way that you assume that someone with a lot of cats probably likes cats. Thus the total utility associated with a transfer of wealth depends on both the level of wealth and the attitude of the giver and the receiver.

Some people could make more money, but they would rather have a life or equate wealth with being a sell-out. Suppose you have two equally able people but one goes into banking because she is materialistic and the other writes poetry because it nourishes his soul. Is it really fair to take money from the banker and transfer it to the poet? Would it be fair to take some of the poet’s soul and give it to the banker? Maybe you think it would be good if the banker had some more soul, but it wouldn’t last. She’d probably just waste the soul to make more money anyways.

The process by which the exchange occurs will also affect utility. Some people may be very charitable and receive greater utility from donating $100 than they would receive from either spending or keeping the money. In the best of both worlds, a wealthy person might gain utility from giving money to a poor person while the receiver gains the utility of $100 worth of food. Now suppose the poor person steals the $100 from the rich person. This has the exact same wealth effect as the charitable donation – the rich person is $100 poorer and the poor person is $100 richer. The utility effect, however, is completely different. The poor person has $100 but may also have the disutility associated with guilt (assuming that the poor person has a conscience). Meanwhile, the rich person has not only lost $100, they’ve lost their sense of security, their power, their independence. In short, they feel violated. Government enforced redistribution of income presumably falls in between the two extremes of theft and charity.
Wealth distribution may also have negative incentive effects. As long as the redistribution involves the fortunate helping out the less fortunate, then it probably increases utility. However, as soon as it crosses that line into punishing the people who made good choices and sacrificed for the future in order to support people who wasted opportunities and ended up poor, then redistribution becomes a utility-reducing activity. Furthermore, it could exacerbate the problem if people become less likely to make good choices and more likely to make bad choices.

This leads to the question of what is done with the money. If the money helps the poor individual get their life on track and eventually out of poverty, then the money is well spent. However, if the money allows them to continue along their current failed path, then the money is wasted.This is not to say that all wealthy people worked hard for their wealth and all poor people are lazy and irresponsible. Some people clearly have better opportunities than others and some people clearly take better advantage of whatever opportunities are given to them. I would personally rather help someone who ended up poor even though they made the most out of their minimal opportunities rather than someone who ended up poor because they wasted the opportunities they had. Unfortunately, it is difficult for government programs to make that distinction. People qualify for help based on their present state, not based on how they got into their present state. Private charity is better able to distinguish among potential beneficiaries in order to determine who most deserves help and who can benefit the most.

Overall, I think these factors cause the utility effects of wealth redistribution to be about half of what a straight analysis would suggest. Basically, you would want to compare the utility loss of $100 of a wealthy person to the utility gain of $50 to a poor person. I have no scientific data to back up this statement, but I’m going to use it as an approximation unless I find reason to change.


  1. Sounds very hypothetical. Let's put the scientific method into practice...Start by sending me $100,and I'll let you know how I feel. That's Colonia Obrera 138, Mexico, D.F.