Should the Law Do Anything About Economic Inequality?

Abstract

What should be done about rising income and wealth inequality? Should the design and adoption of legal rules take into account their effects on the distribution of income and wealth? Or should the tax-and-transfer system be the exclusive means to address concerns about inequality? A widely-held view argues for the latter: only the tax system, and not the legal system, should be used to redistribute income. While this argument comes in a variety of normative arguments and has support across the political spectrum, there is also a well-known law-and-economics version. This argument, known as the “double-distortion” argument, is simply stated. Legal rules that redistribute income only add to the economic distortions that are already present in the tax system. It would therefore be better for everyone, and especially the poor, to instead adopt an efficient, nonredistributive legal rule, and increase redistribution through the tax system.

This Article challenges the double-distortion argument from a law-and-economics perspective. There are two main arguments, in addition to several other subsidiary points. First, in the abstract, there is no reason to believe that legal rules that have redistributive effects will always reduce efficiency; indeed, they can sometimes increase efficiency. Examples from the regulation of product markets, labor markets, and financial markets underscore this claim. In these cases, legal redistribution is more efficient than redistribution through the tax system. Second, legal rules are likely to be more attractive than taxation precisely in cases where inequality itself or normative concerns about inequality is high. Under the optimal tax policy, higher inequality or greater concern about inequality will justify larger tax distortions. Therefore, a particular legal rule is more likely to be more efficient than the optimal tax policy under these circumstances. The ultimate conclusion is that a mix of legal rules and taxation, rather than taxation exclusively, will be the best way to address economic inequality.

Keywords: law, taxation, inequality, efficiency, equity, double-distortion argument