Who Wants Kid $ Insure?

Financial inequality seems to be shaping up as a central issue in the US presidential campaign. (Other sorts of inequality, not so much.) Many note that such inequality has increased in recent decades. But let me repeat my anti-trend-tracking matra: if what matters is the efficiency of our institutions, trends are irrelevant unless they reveal such inefficiencies. So are the institutions that influence our financial inequality inefficient?

Probably the simplest and strongest argument is insurance market failure: being risk-averse, we want to insure against variations in our distant future income, but since this insurance is not available privately, governments must provide it. Why exactly this is not available privately if customers want it isn’t usually clarified. And it could be that the incentive costs of the insurance outweigh its risk-reduction benefits. But this is at least in the ballpark of a plausible institutional argument.

However, it seems to me that as a parent I wouldn’t have wanted to insure against any but the very low tail of possibilities of for my kids future income. I like the idea that one of my kids might someday be very successful or famous. And asking this of my undergrads consistently gets the same answer – very few want such insurance for their own or their kids’ future. Furthermore, parents do not much use the one clear insurance option they have – to teach their kids to share their future income with each other. Most societies used to do this, and our culture evolved away from that. So while teaching kids to share income is both personally and culturally possible, we just don’t do it.

Now you might argue that this is a signaling failure – that we would each in fact like such insurance, but dislike what our willingness to take it would say about us. But you could also tell your kids to keep this income-sharing policy a family secret, only to tell potential spouses. And once such sharing became a long family tradition then continuing it would say much less about personal features. But it seems to me that even if given the option to legally commit all their descendants to such a policy, to prevent all future signaling about it, most folks would still reject such insurance.

Thus it seems to me that most folks think the incentives costs outweigh the risk-reduction gains for such insurance, and do not want it. Thus the insurance market failure rationale for taxing the rich extra just fails.

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  • Owen Biesel

    Thank you for such an interesting post! I had never even thought of the possibility of private income insurance.

    “And it could be that the incentive costs of the insurance outweigh its risk-reduction benefits.” Whether this is the case or not, I can easily see it being a worry that prevents parents from compelling their children to share their income. If Joey keeps requiring external motivation to get his homework done, the promise of future support from his sister might be counterproductive.

  • david

    Is common property the same as insurance? Surely there is a difference between “your brother is dissolute and can find no gainful employment – give him half your wealth” and “your brother has been hit by a car and is paralyzed for life – give him half your wealth”?

    • Daniel

      Your brother has more control over his employment than getting hit by a car.

      Beyond that, I don’t see a relevant difference. You get insurance against being hit by a car so it’s not as bad if you’re unlucky enough to get hit by a car. You get insurance against being a bad worker so it’s not as bad if you’re unlucky enough to be a bad worker.

  • Mark M

    I agree that most people do not want this sort of insurance.

    But I don’t think it’s a conscious choice. Taking out a policy is basically betting against yourself. Americans love confidence and competition, in business as well as sports, and this sort of insurance signals a lack of confidence in yourself. Even if it could be done secretly, I believe many Americans would not want to admit this lack of confidence even to themselves, let alone anyone else. I believe most Americans would not even allow themselves to consider such a policy, let alone weigh it on its merits.

  • WL

    Remember that everyone dramatically overestimates the role of chance in life. Most people probably wouldn’t take this insurance because they overestimate how much their own skill will reward them and underestimate how much role chance plays in success.

    Also, keep in mind that capitalism is ultimately about how we distribute our labor. The problem with tremendous wealth inequality is that as the distribution gets more skew, we stop doing work for one another, and we mostly do work for the few at the top. We could have an economy where most people work on luxury goods for the elites, but thats probably less preferable then an economy where we produce things most people want.

  • Michael Wengler

    I don’t think it is income or wealth inequality per se which is the interesting issue. Rather, it is tax policy.

    I don’t care if you have a million or a billion or a trillion. I do care if kids have crappy schools and there are homeless people I have to drive over to get to work or if the government debt is so large that financial policy no longer works without high inflation or ridiculously enriching executives or some such.

    The issue isn’t whether Romney has more income than I do. It is that he pays a lower fraction of his income in taxes to support these things than I do.

    I HIGHLY recommend Robert Frank’s book Darwin Economy if you haven’t read it yet. He deals with income inequality and tax policy brilliantly, in a way you would admire if you like this blog.

    • Wonks Anonymous

      I believe Frank argues in favor of consumption taxes. Romney pays a low tax rate because it’s not “income” but “capital gains”.

      • http://daedalus2u.blogspot.com/ daedalus2u

        The “gains” that Romney made may have been categorized as capital gains for tax purposes, but what they really were is transfers of value due to broken implicit expectations.

        http://www.economics.harvard.edu/faculty/shleifer/files/breach_of_trust.pdf

        It was not wealth creation through increased efficiency, it was wealth transfer by breaching implicit agreements.

      • Doug

        Frankly I find the argument of breaking implicit agreements to be crap. Basically what you’re trying to say is that laying off a long-time employed worker is equivalent to contract breach. “Because well, you know ol’ Gary always expected to work at that plant.”

        If anything pre-industrial peasants had FAR more of an implicit guarantee of lifetime employment than modern day corporate workers. Yet would you try to argue that the industrial revolution was not “value creating.”

        Reductio ad absurdum.

      • Michael Wengler

        Another interesting thing he covers is that higher income “should” pay more taxes because they are WILLING to pay more for the goods it brings them.

        Yet another interesting thing he covers are positional goods where an 80,000 sq ft house signal you are richer than the guy with the 70,000 sq ft house and this would work just as well if there were taxes on these things and it was 40,000 and 35,000 sq ft houses after tax.

        The book covered a LOT of good ideas and interesting analyses.

      • http://daedalus2u.blogspot.com/ daedalus2u

        Doug, did you read the article? Take-overs are not necessarily profitable only by the breaching of implicit agreements, but breaking those agreements can be highly profitable to those who get the benefit.

        There are examples in the article.

  • Wonks Anonymous

    You already gave your own theory for why tax policy redistributes here:
    http://www.overcomingbias.com/2009/06/redistribution-isnt-about-sympathy.html

    I remember a while back someone arguing that firms (and possibly people) buy insurance rather than “self-insuring” because they want to signal responsibility and avoid blame in case something goes wrong. It’s the same kind of logic behind most product warranties being a ripoff. I can’t find the post though.

  • David C

    If someone steals a penny from me, I’m not going to expend a lot of time and effort to try and get that penny back. If somebody steals a penny from everyone, that someone will be incredibly rich. It is essentially impossible to insure against being in the bottom 99%. The anger is not that the public feels like they’ve lost a lot, but that a few people have gained a lot that they didn’t deserve. The 1% are there by taking pennies from the 99%. This is the impression I get of pubic opinion, anyway.

    • KPres

      Of course the problem is the public’s information is incorrect. The “top 1% don’t control a significantly larger portion of the nation’s wealth today than they did in 1965.

  • CaptBackslap

    More inequality is, ceteris paribus, always less efficient as far as producing utility, since the marginal utility of money falls off so fast once you get past a relatively low threshold. The only question is whether the downsides of redistributive policy overwhelm the gains.

    • Anonymous

      That seems hard to believe unless they are significant. OTOH, there’s a psychological framing element of “I earned this and they took it from me by force” that destroys motivation and causes additional disutility. I’d still expect that relatively solid redistribution does more good than harm, unless it contains bureaucratic elements that create additional inefficiency (overhead, perverted incentives etc).

  • http://timtyler.org/ Tim Tyler

    Richard Wilkinson laid out the argument for wealth inequality being harmful recently – in his: “How economic inequality harms societies” – http://www.ted.com/talks/richard_wilkinson.html

  • Faul_Sname

    But you could also tell your kids to keep this income-sharing policy a family secret, only to tell potential spouses.

    And you know they don’t… how again?

  • http://juridicalcoherence.blogspot.com Stephen R Diamond

    >Why exactly this is not available privately if customers want it isn’t usually clarified. And it could be that the incentive costs of the insurance outweigh its risk-reduction benefits.

    The reason isn’t clarified because the incentive-based reason is obvious.

    >And asking this of my undergrads consistently gets the same answer – very few want such insurance for their own or their kids’ future.

    Did the answers determine their grades?

    What’s the hypothetical price of this insurance? Are you saying students would refuse it, even were it free? This would seem blatantly irrational, in light of studies purporting to show that the marginal utility of income increments over $75,000 is negligible. The price of such insurance would be prohibitively high, and your students might have taken the probable price into account.

    Otherwise, I’d just have to say you must have particularly stupid students. I think the vast majority would take advantage of such insurance for themselves, were it freely available.

    Your argument about families “teaching” their children to share is fatuous because you assume parents have powers they don’t in “teaching” their kids’ “values.” But while I’m sure people would want this insurance for themselves, I don’t have a prediction on whether parents would want it for their kids. I don’t think the average parent is all that well-intentioned about their children. Their *personal* interest lies in having one of them get rich.

    • Ilya Shpitser

      It’s pretty obvious the marginal utility of income over $75,000 isn’t negligible.

      • http://juridicalcoherence.blogspot.com Stephen R Diamond

        >It’s pretty obvious the marginal utility of income over $75,000 isn’t negligible.

        It’s a counter-intuitive result. Keynes diagnosed the source of the counter-intuition long ago:

        “The love of money as a possession – as distinguished from the love of money as a means to the enjoyments and realities of life – will be recognised for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease.”

      • http://daedalus2u.blogspot.com/ daedalus2u

        I disagree, what drives some of the very wealthy is the desire for money as a means of obtaining social power, not because of material possessions it can purchase.

        The problem is that social power is zero-sum, and wealth is only useful in obtaining social power if wealth acquisition is limited. Those who would acquire wealth as a means of obtaining social power have to prevent others from getting wealth or their wealth is not useful.

        This is why people like Romney want low taxes on capital gains and interest and high taxes on earned income.

      • http://infiniteinjury.org Peter Gerdes

        > This is why people like Romney want low taxes on capital gains and interest and high taxes on earned income.

        No, he wants that for two reasons:

        Primarily he wants it because he thinks it will help him become the president. Secondly, he wants it because he doesn’t want to fork over his cash but doesn’t want the government to go bankrupt and this is the easiest way to do that.

        Your reasoning should have him actually favoring taxes that hit the other rich people but avoid him. No matter what tax policy is adopted the middle class won’t even come close to his level of money so they don’t threaten his positional prestige/influence regardless of tax policy. The people it’s most in his interest to beat down are those who are also rich and can present real competition for (money based) influence/prestige.

        Ultimately, however, I doubt Romney really thinks that much about money as a positional good nor spends time scheming to raise his position. Like everyone else he probably just finds it unpleasant to fork over his money to the government and also like everyone else finds whatever justification is convenient to explain why he should be paying less.

      • KPres

        Oh for God’s sake. The reason people want lower capital gains taxes is because it’s a form of income that’s highly sensitive the Laffer Curve. That’s why EVERY SINGLE COUNTRY in the world taxes it lower rate than regular income.

  • Kevin

    I’ve thought about this a little, but with a twist. Basically I want to become rich to provide a form of insurance against bad events and “low tail” kids. However, I don’t want my kids to know about my wealth lest their incentives to work hard and/or choose profitable careers deteriorate (not to mention the satisfaction they would miss out on if they never felt that they were ‘self-made’ men and women). To keep incentives aligned, I would add an extra layer of secrecy between generations within a family. When bad events occur, I could pretend to mortgage the house when in reality I’m paying it off in cash. Eventually I inform my adult children of the wealth so that they can do the same with their kids, etc.

  • Gabriel Weil

    Isn’t it possible that at least part of what people want insurance against is the circumstances of their birth. That is, some people are born with better genetic endowments and family circumstances and by the time they are born it is too late to buy insurance against a poor drawing in the genetic / environmental lottery. I’m not sure whether people would want this sort of insurance if they could somehow freely contract for it, but it is clear that there are pretty fundamental barriers to private provision of it. It is also worth noting that birth position is much more purely a function of luck than life success is. Insurance that incorporated this aspect would have a more favorable mix off hedging risk and creating moral hazard / weakening incentives.

    • http://juridicalcoherence.blogspot.com Stephen R Diamond

      >Isn’t it possible that at least part of what people want insurance against is the circumstances of their birth.

      Excellent point.

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