There is a fundamental misunderstanding of income in America, and this misunderstanding of income is at the heart of differences of opinion about income inequality. I came to this conclusion long ago, but it has been increasingly reinforced over recent months as the Occupy Wall Street movement has sparked more conversations about income inequality.
A fundamental tenet of neoclassical capitalist economics is the notion that "everyone is paid the value of their contribution". Not only is this a very fuzzy notion but it breaks down in all kinds of ways. Nevertheless, this concept, this idea, that in our economic system everyone's pay is an inherently exact measure of the value of their contributions is the core foundation of our entire economic system. The assumption that this is true is the foundation upon which every aspect of our economic social contract is built.
Yet, this foundational tenet is wrong, and understanding this is the key to everything; not just understanding that this tenet is wrong, but understanding that belief in this tenet is essential to the acceptance of our economic system, and that acceptance or non-acceptance of this tenet is the primary driver of public perception and disagreement on essentially every aspect of economics in America.
This starting assumption, that incomes precisely reflect contributions, drives all downstream views of economic justice. If the exact same logic is applied under two different starting assumptions, 1) that all incomes always accurately reflect the value of the contributions of the individual or 2) that incomes do not necessarily accurately reflect the value of the contributions of the individual and that there can be massive disconnects between contributions and incomes, two completely different conclusions will be reached.
This is, to a large extent, the only thing that really separates Marxists from libertarians. Marxists and libertarians essentially apply the exact same set of logic to two different starting assumptions, the libertarian assumption being that incomes are inherently accurate reflections of contributions, the Marxist assumption being that incomes can be greatly distorted and tend to be distorted in favor of the wealthy, or more precisely, tend to be distorted favor of capital owners.
The position of both Marxists and libertarians is that "redistribution is unfair". That is the driving logic of both worldviews, the difference is that Marxists argue that redistribution happens between the creation of value and the realization of incomes, while libertarians argue that incomes are inherently fair, and that thus taxing different levels of income differently is a form of unfair redistribution.
The evidence against the assumption that incomes inherently reflect contributions is, however, overwhelming. But even when people acknowledge that incomes don't always accurately reflect contributions the full implications of this fact are seldom fully comprehended. People still generally don't understand the fact that if someone receives more income than is warranted by their contributions then it necessarily means that someone else has to receive less. Many people take the view that, well even if CEOs are over paid, good for them, it does me no harm. But that's not true (for mulitple reasons).
Every business operates on a fixed budget. Ignoring borrowing, basically everyone is paid a portion of the revenues. If the net revenues are $1,000,000 and there are 10 employees, that can be divided up lots of different ways, but however its done the amount that can be paid to any employee is relative to the amount paid to the other employees. Divided evenly, all ten employees would be paid $100,000, but if one employee is paid $500,000 then that means everyone else has to be paid out of the remaining $500,000, which means that if the remaining employee's income were distributed evenly from the remaining revenue they would each be paid $55,555, a lot less. It's no different in any business or corporation.
When one person is paid more everyone else has to be paid less. That's not a problem if incomes accurately reflect contributions, but if anyone is over-paid, i.e. paid more than the value of their contributions, then that means everyone else has to be under-paid, and that's exactly what's happening in our economy right now, and it goes well beyond that when we start talking about capital income vs. wage income.
But let's address this notion that incomes accurately reflect contributions head on. This idea is based on market theory, and, as is so often the case, the conclusion that compensation accurately reflects contribution only holds true in market theory under ideal market conditions. And this is the crux of the whole matter. Market theory itself doesn't say that incomes magically automatically always reflect the value of contributions, market theory says that theoretically this will be true, only under ideal market conditions, which, of course, never exist! What today's so-called "conservatives" (they aren't actually conservative at all, they are radial market liberals) and apologists for the super-rich do is they pull a scam; their arguments proceed from the unstated assumption that we are operating under ideal market conditions, and not only that, but they also tend to infer that if market conditions are less than ideal then market conditions result in a redistribution of income from high to low, when in fact market theory itself (classically developed as a critique against the the rich feudal aristocracy) states the opposite.
An obvious example of this is provided by the recent study on executive compensation which found that executive compensation at top American corporations is set by board members, many of whom are picked by the executives whose compensation they determine, and through a system of always automatically setting pay packages above the industry average. Basically this means that executive compensation isn't determined by market principles at all, indeed the determination of executive compensation completely violates every market principle. Executive compensation is in fact set along the lines of the corrupt system of interpersonal relationships and favoritism that economists and philosophers like Adam Smith and John Locke railed against. And this is just the tiniest tip of the iceberg.
I believe that if we were able to do a study in major American corporations, where we recorded the actual work-products of every employee, executive and board member, and we removed the names of the people from the list, then we attempted to objectively evaluate the "market value" of each work-product itself, and then we tied those work products back to the employees and totaled up the values by employee, what we would find is that no one's actual compensation would match the value of their work products. In fact what we would find is that there would be huge disparities between pay and actual value creation across the board with many people creating more value than their pay and many people creating less than their pay, but most importantly what we would find is that the biggest disparities would be for those with the highest pay.
The reality is that redistribution takes place within any business that has more than one "employee" (self-employed), and I would estimate that the amount of redistribution that takes place within large corporations is tremendous, with the overwhelming majority of that redistribution being redistribution from lower level workers to executives. If a corporation with 10,000 employees underpaid every worker by an average of just $500 a year that would amount to $5,000,000, which could then be paid to the CEO. You think this isn't happening?
Let's again consider an obvious example: the case of the Washington Mutual CEO who received almost $20 million in compensation while on the job for only 17 days, during which time the bank collapsed and had to be taken over by the government. It is obvious in this situation that the CEO, Alan Fishman, didn't create $20 million in value, which means that his pay was a form of redistribution. The only way to pay someone more than the value that they create is to redistribute value that was created by someone else.
That's an extreme example, but executives at major corporations across the board are over compensated. They've established a system where executive compensation is completely shielded from market forces, while average workers are put into competition with computers, machines, foreign workers and each other to drive compensation down. And again that's just the start of it, and doesn't even begin to approach the issue of folks like hedge fund managers and the entire financial industry, who not-only clearly benefit from market inefficiencies, but who actively work to create and expand market inefficiencies, both through government influence and the engineering of the private financial system.
But this is the issue, in America we are taught that the measure of someone's contribution is their income. The concept that someone's income might not actually reflect their contributions is totally foreign to many Americans. This belief that incomes always reflect contributions is reflected in the fact that in virtually every situation people in America use the term "earned" or "made" to describe income, even when decrying incomes as unjustified! There were dozens of articles written about how Alan Fishman had "earned" $20 million for only 17 days of "work", virtually all of which decried the income as an example of out of control executive compensation practices, yet it not one single article that I've read about this did anyone even address the fact that this money had to have come from someone else, nor did they clearly state that he didn't actually "earn" that money. We also see this reflected in the way that everyone, and I mean everyone, who covers the individuals on Wall Street always talks about how smart they are. In any article, documentary, or broadcast you see on the subject of high finance there is always an obligatory statement about how these guys are "wizards", or the "smartest guys in the room", or "geniuses", yet these obligatory statements aren't made even when discussing the work of major pioneers in computer engineering or biological science or chemistry, etc.
There is an instinctive need to justify the incomes of the super-rich by attributing super-human capability to them, but the reality is that they aren't super-human, they aren't thousands of times smarter than the average guy, no one is.
The underlying assumption in America, however, is that all income is eared all the time... but it isn't!
The notion of even objectively evaluating an individual's contribution in any way other than simply citing their income is so foreign to many Americans that when you even raise the subject they get so flustered and confused by it that you can't even proceed. We've established income as the self-definition of contribution in this country, with no way to objectively evaluate contribution by itself, under the assumption that "markets" always correctly establish the value of every individual's contributions, and all incomes are determined under perfect market conditions (even though we all know that perfect market conditions don't now, never have, and never will exist).
The result is that we have a situation where when someone like John Paulson brings in over $5 billion that people just scratch their heads and "Wow". But the notion that John Paulson "made" $5 billion in a single year is totally absurd. For that to be true John Paulson would have to have created as much value as 100,000 workers with an income of $50,000 each. It's like saying that John Paulson built 200,000 cars all by himself in a single year, while the "average American" can build about 2 cars a year.
The "cult of the super-rich", the worship of the super-rich, the belief that the super-rich are exponentially superior to the average person, is all a result of the belief that incomes accurately measure individual contribution. If that were actually true then it would in-fact mean that some individuals are thousands of times "better" and "more productive" than the average person, but no one is 1,000 times smarter or 1,000 times harder working than the average person, they simply aren't. Maybe 2 time or 3 times or maybe even 10 times, but not 1,000 times, not even 100 times.
So now what we have is a situation where we have two conflicting sets of beliefs, and what happens is that people will rationalize one set of beliefs in order to maintain the other. In order to maintain the belief that our economic system is even remotely fair, or that incomes are even remotely reflective of contributions, you have to believe that some people are thousands of time more productive than the average person. If some people aren't thousands of time better than the average person then our economic system can't possibly be justifiable, because our economic system rewards some individuals thousand of time more than the average individual.
What we see regarding beliefs about our economic system is very similar to what we see in religion and other areas of strongly held beliefs, like beliefs about loved ones, etc. where some people's beliefs are so important to them, so central to their entire worldview, that they automatically rationalize anything that would contradict their core beliefs, and one of the core foundational beliefs of "America" is the belief that we have a "fair" economy.
So, the situation that we face is that for many people, the belief that America has a fundamentally fair economy is so central to their worldview that anything that would undermine this belief is vehemently attacked, denied, rationalized, or ignored. Its just like a parent that may never be able to accept the fact that their son raped and murdered their daughter, or something horrific like that, where they would come up with all kinds of explanations in contradiction to the facts to rationalize in their mind how it had to have been someone else. Or how a religious person who believes that god rewards good people and punishes bad people on earth will conclude that everyone "deserves" every bad thing that happens to them and everyone who does well is an inherently "good person". When faced with examples of nice young children that are stricken with cancer such a person will rationalize that the child had a "bad soul" or something because the belief that peoples' conditions are a result of god's grace is so central to their worldview that they can't accept anything that would call that belief into question.
This is where we are in America today, and we have to acknowledge that and understand it. We have a fundamentally unjust economic system, where incomes are not necessarily reflective of contributions, in which the biggest incomes in this country are the most unjustifiable. At the same time we essentially have a national religion in which the belief that everyone's income is "earned" is central to the worldview and people don't want to believe that their worldview is fundamentally wrong. People don't want to believe that we have a fundamentally unjust economic system. Economic fairness and the superiority of our economic system so are central to the identity of America, that for many Americans its a belief that they cannot challenge, no matter how many facts they have to deny or what other beliefs they have to hold in order to rationalize it.