Reducing Inequality on the Cheap: When Legal Rule Design Should Incorporate Equity as Well as Efficiency
Liscow, Zachary, The Yale Law Journal
NOTE CONTENTS INTRODUCTION I. REDISTRIBUTION BASED ON INCOME A. Equity-Informed Distribution of Entitlements and the "Zero Distortion" B. Contrasting Alternative Equity-Informed Legal Rules C. Factors that Affect the Value of Equity-Informed Legal Rules 1. How Effectively Income Can Be Redistributed Based on Group Membership 2. Elasticity of Group Membership 3. Timing of Income Transfers and Behavioral Responses 4. Economic Incidence 5. Bargaining Costs 6. Importance of Helping the Poor Versus Horizontal Equity II. REDISTRIBUTION BASED ON NON-INCOME FACTORS A. Tagging B. When Insurance and Transfers Are Unavailable or Not I-Efficient CONCLUSION
At least since the majority in Lochner v. New York (1) found that bakers' hours could not be limited by the government, many scholars have argued that legal rules should not try to affect the distribution of income. What many consider the decisive argument in favor of this position is the idea of "double distortion" offered by Louis Kaplow and Steven Shavell: using legal rules to affect the distribution of income merely simulates income taxes, distorting income just like a tax but also distorting the behavior regulated by the legal rule. (2) As a result, they argue, all redistribution should take place through the income tax code, and none should take place through legal rules. The argument is especially sweeping given the scope of what a "legal rule" can be: regulations on bakers hours, tort laws, methods of conducting cost-benefit analysis, or any "rules other than those that define the income tax and welfare system." (3)
Kaplow and Shavell's analysis supports what is perhaps the central tenet of law and economics, namely that legal rules should be designed based on their efficiency consequences. (4) That is, legal rules should lead to behavior that maximizes "wealth," the sum of individuals' willingness to pay for the externalities, goods, and services produced by an economy. (5) But traditionally, economists have sought policies that maximize not wealth but rather "social welfare," the sum of individuals' utility, (6) and utility often increases more when a resource is distributed to individuals, especially the poor, who are not the ones most willing to pay for it. In other words, equity, or distributing resources to individuals whose utility is most increased by receiving the resource, matters for utility too. In the classic trade-off between efficiency and equity in social welfare maximization, "distortions" to the wealth-maximizing outcome resulting from deviating from the "efficient" rule must be traded off against improvements in equity that result from the "distortion." Kaplow and Shavell's "double distortion" argument, however, eliminates this trade-off for legal rules. In their world, taxes should be the sole means of promoting equity.
Kaplow and Shavell's argument has been criticized from inside and outside of law and economics. In particular, Chris Sanchirico and others claim that equity should be taken into account when designing legal rules. (7) Kaplow and Shavell themselves acknowledge that their argument does not always hold, but they do relatively little to explore exactly when this is or to define the optimal policy under those circumstances. This Note seeks to map the territory between the two sides by answering two questions: (1) When exactly does the double distortion argument not hold? (2) What should policymakers do at such times? This Note argues that, within traditional economic understandings of welfare maximization, legal rules should consider equity for two reasons. (8) First, legal rules may be more efficient than income taxes at redistributing income from the rich to the poor. While this Note does not advocate for more redistribution, as income inequality increasingly becomes part of the political dialogue, finding efficient ways of reducing income inequality may be increasingly important. …