The University of Chicago

The Booth School of Business of the University of Chicago

The University of Chicago Law School
Director's Law of Public Income Redistribution
Author(s): George J. Stigler
Source: Journal of Law and Economics, Vol. 13, No. 1 (Apr., 1970), pp. 1-10
Published by: The University of Chicago Press for The Booth School of Business of the University of
Chicago and The University of Chicago Law School
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DIRECTOR'S LAW OF PUBLIC INCOME
REDISTRIBUTION
GEORGE J. STIGLER
University of Chicago
ALMOST
a decade
ago
Aaron Director
proposed
a law of
public expendi-
tures: Public
expenditures
are made for the
primary
benefit of the middle
classes,
and financed with taxes which are borne in considerable
part by
the
poor
and rich. The law was
empirical,
and the
present essay
seeks not
only
to
present
and illustrate the law
(which
its inventor refuses to
do)
but to
offer an
explanation
for it.
The
philosophy
of Director's law is as follows. Government has coercive
power,
which allows it to
engage
in acts
(above all,
the
taking
of
resources)
which could not be
performed by voluntary agreement
of the members of
a
society. Any portion
of the
society
which can secure control of the state's
machinery
will
employ
the
machinery
to
improve
its own
position.
Under a
set of conditions to be discussed
below,
this dominant
group
will be the
middle income classes.
I. DIRECTOR'S LAW ILLUSTRATED
A
reasonably rigorous
demonstration that the state redistributed income
in favor of the middle income classes would
require
vast
empirical
studies
of the distribution of
public revenues,
non-revenue
burdens,
and
benefits,
by
income class. We are content here to defend the
plausibility
of Director's
Law.
The distribution of incomes of
parents
of students in California institu-
tions of
higher
education is
highly
skewed toward
larger
incomes
(see
Table
1).
California is a
relatively wealthy
state so somewhat lower incomes
would be received
by parents
in other
states,
but no defensible
adjustments
of the data would
qualify
the assertion that the
colleges
of America are
populated by
the children of the middle and
upper
classes. The
rough
estimates of the distribution of state and local taxation
by
income classes
are
persuasive: public provision
of
higher
education redistributes income
from the
poorer
to the
higher
income classes.
The same redistributive
effect,
one
may conjecture,
was achieved in
equal
degree by
the
public provision
of
high
school education
thirty years ago,
and
1
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2
THE
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OF LAW AND ECONOMICS
TABLE 1
DISTRIBUTION OF PARENTS OF STUDENTS IN CALIFORNIA COLLEGES AND UNIVERSITIES
BY
INCOME, 1964,
AND RELATED DATA
1964
Percentage
of Parents
1965 State 1961 Share
1964 and Local of Total
University Percentage
Taxes as State
State of of all U.S. Per cent and Local
Income Class
Colleges
California Families of Income Taxes Paid
Under
$4,000
4 5 26 11 17
$ 4,000-$ 8,000
27 19 38 10 46
$ 8,000-$14,000
48 38 27 9 27
$14,000
and over 21 39 9 8 9
Sources: Parents income:
J.
Edward Sanders and Hans C.
Palmer,
The Financial Barrier to
Higher
Education In
California;
A
Study Prepared
for the California State
Scholarship
Commission
(1965).
Family
income: U.S. Bureau of the
Census,
Statistical Abstract of the United
States,
Table
472,
at
324
(1968) [approximate].
Taxes as Per cent of Income and Share of Total Taxes: Tax Burdens &
Benefits of Gov.
Expenditures by Income
Class,
1961 and
1965,
Tables
7,
B-9 (Tax Foundation, 1967)
[approximate].
even
today
the
parents
of
high
school
graduates
are
primarily
in middle and
upper
income classes. In the nineteenth
century
the same
analysis
would
apply
to
elementary public schools;
the
graduates
of
elementary
schools in
1900 were
probably largely
from middle income class families.
The main beneficiaries of several other traditional
governmental
functions
appears
to be much the same. Fire and
police activities,
for
example,
are
clearly
middle-income oriented to the extent that
they protect property,
and
it would be
interesting
to
investigate
the extent to which such activities are
provided
more
liberally
in middle than in lower income areas of cities. But
the
major examples
of the use of the state
by
the middle classes lie elsewhere:
1. Farm
policy.
The basic method of
assisting
farmers has been to raise
prices by restricting output,
and the restriction of
output
has been based
upon
the use of land. The beneficiaries of the
policy
have therefore been the
farm land
owners,
not the
poorer
farm laborers and tenants. The burden of
the
system
has been
placed upon
the consumers of farm
products-a regres-
sive excise
tax,
in effect-as well as on the
public treasury.
The redistribution
of income has therefore much exceeded direct
governmental expenditures.'
2. Minimum
wage
laws. The main beneficiaries of minimum
wage legislation
have been two
types
of workers. The first is the
higher paid
Northern worker
(in textiles,
for
example)
who received some measure of
protection
from the
Southern, low-wage
branch of the
industry.
The second class of beneficiaries
has been the
better-paid workers,
for whom the
lower-paid
workers are an
1
See John
E.
Floyd,
The Effects of Farm Price
Supports
on the Returns to Land and
Labor in
Agriculture,
73
J.
of Pol. Econ. 148
(1965).
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DIRECTOR'S LAW OF PUBLIC INCOME REDISTRIBUTION 3
important
substitute. The income
redistribution,
which is not
part
of the
public budget,
is financed
by
the workers who are
displaced by
the minimum
wage
statute and the consumers who
purchase
the
products
of
low-wage
industries.
3. Social
security.
The social
security system
taxes most
heavily,
relative to
the benefits
they
will
receive,
i. Those who
begin
work
early,
as
compared
with those who continue in
school.
ii.
Those who die
early,
as
compared
with those who live
longer.
iii. Those families in which the wife
works,
relative to those in which she
does not.
iv. Those who were
young,
as
compared
to those who were
old,
when first
covered
by
the law.
All of these effects are in favor of the middle classes. There are other effects
which run in favor of lower income classes
(for example,
benefits are a lower
fraction of
average wages
as
wages rise),
but it is
quite possible
that the
system
on balance redistributes income to the middle classes.2
4. Public
housing.
The
public housing program
has had for its
primary pur-
poses
the reduction in the
density
of
population
and
improvement
in the
quality
of
structure,
with the
implicit
rise in
housing
costs offset to some
extent
by public
subsidies. Even when the new
housing
is made available to
those
displaced, many
of the
displaced
cannot be rehoused in the
area,
and of
course the more attractive
housing
attracts the
competition
of those who are
better off. The
public housing
has therefore at a minimum
injured many
of
the
poor,
and in
good
measure benefited the
non-poor.3
5. Tax
exempt
institutions. One form of
subsidy
is tax
exemption,
and if we
examine the classes of institutions which were
given
tax
exemption,
we find
that
they
were
primarily
those which served the middle classes. Churches are
the
largest
of the tax
exempt institutions,
but educational and medical insti-
tutions are
equally
directed to the middle classes.
6.
Welfare expenditures.
Public charitable
expenditures
in the nineteenth
century
could be viewed as the transfer to the state of burdens otherwise
necessarily
borne
by
the well-to-do. The
great
modern
programs presumably
involve net transfers to the
poor
and are therefore
apparently contradictory
to Director's Law. We shall return to this
category
of state
expenditures.
2
This
argument implicitly
assumes that workers bear the
tax;
if consumers bear a
portion,
the conclusion is even more
likely.
3
See Martin
Anderson,
The Federal
Bulldozer,
A Critical
Analysis
of Urban
Renewal,
1949-1962
(1964).
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4 THE
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OF
LAW AND ECONOMICS
There remains that
enormously expensive
social
activity,
war. Have the
middle classes been the
special
beneficiaries of war?
Possibly
some
wars,
such
as the American
Revolution,
could be viewed as
levying
a
highly progressive
tax on the
wealthy loyalists.
Modern
wars, however,
are not
easily
viewed
as
profitable
to
any
income class
(although by
devices such as
conscription
the middle classes reduce the costs to
them). Simply
to
put
aside a
large
sub-
ject
which should
not
be dismissed
simply
as
pathological,
wars will be
adduced neither as
support
nor counter-evidence on Director's Law.
II. THE BASES FOR VOTER COALITIONS
A
majority
coalition of voters
may
be formed
upon any
of a
variety
of
bases:
religion, nationality, region, industry,
or
income,
to mention
only
a few
historically important
bases. If the coalition of voters is to make effective
use of the
political machinery
of the state to redistribute
income,
it must
find a state
activity (expenditure)
whose benefits flow to the coalition in
greater proportion
than the taxes which will finance the
activity.
In the nineteenth
century
there were
relatively
few available tax bases or
functions
(expenditure categories)
which were
closely
related to income.
The federal
governmental
revenues
(the
Civil War
period aside)
were either
custom duties or excises
upon liquor
and
tobacco,
and of course the burden of
commodity
taxes is
only loosely
related to income. The
overwhelming pre-
ponderance
of state and local
governmental
revenues came from the
general
property tax,
which
again
bore
only
a loose
relationship
to income.
(The
tax
on
land, indeed,
would be
capitalized
and have no
necessary relationship
to
even
property
incomes at later
times.)
In the nineteenth
century,
in sum-
mary, only
unconcealable assets
(real property)
and commodities which
passed through
bottlenecks
(a port,
or
large production processes)
and were
inelastic with
respect
to taxes were feasible
objects
of taxation.4
4
The
elasticity
of
supply
with
respect
to taxes is determined
by
both demand and
supply
elasticities. Let
f(q)
be the demand
price
and
h(q)
the
supply price,
so before
tax
f(qo)
=
h(qo).
After a unit tax of
t,
the
equilibrium
is
given by
f(qo
+
Aq) + t
=
h(qo
+Aq),
and expanding
in a
Taylor series,
Aq =
h'(qo)
-
f'(qo)
and the
elasticity
of
output
with
respect
to the tax is
Aq
t 1
q p
1 1
where is the elasticity of supply and the elasticity of
demand.
where e is the
elasticity
of
supply
and
q
the
elasticity
of demand.
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DIRECTOR'S LAW OF PUBLIC INCOME REDISTRIBUTION 5
If the state is to be used to redistribute
income,
the activities itt under-
takes are also limited.
Normally
it will not be
possible
to
give any commodity
(or
sell it at subsidized
prices)
to a
particular class,
unless the allotments of
the commodities to individuals can be
effectively rationed,
because the mem-
bers of this class will
simply
resell the
commodity
to other classes. Redistribu-
tion is a form of
discrimination,
and is
subject
to the usual limitation that the
classes discriminated
against
not be able to deal with the classes who are
favored. Services are
generally non-transferable,
and on reflection it is a
remarkable fact that the state has almost never
supplied anything
but
services."
In the nineteenth
century
there were
relatively
few services which the
state could
supply only
to favored income
groups.
The
protective
functions
(the
courts and
police functions,
in
particular)
and a measure of trans-
portation
and educational services were of
special
value to the
upper
income
classes,
but as with taxes the
relationship
to income was not close.
With both
expenditures
and taxes
largely
unrelated to income in the nine-
teenth
century,
we are not
surprised
that
relatively
little use was made of the
state as an instrument of income redistribution. One
may conjecture
that
other bases of classes
(regional,
urban v.
rural)
entered
largely
into the de-
termination of
public
activities.
Increasingly
in the twentieth
century
income has become a more
important
basis of
political
classes. Income taxes and an almost unlimited
variety
of
excise taxes
gradually
became
feasible,
that is collectible at tolerable costs. A
modern state is
by
no means unrestricted in its
ability
to
assign
tax liabilities
to various income classes-in fact even the
ability
of families to divide in-
come
among
members is an
important
restriction. Nevertheless
changes
in
economic
organization (for example, employment by large organizations
rather than
self-employment)
and in the
recording
of economic information
have
greatly
increased the
power
and
flexibility
of taxation.
There has been a
corresponding enlargement
of the
eligible expenditure
programs.
Services have increased
generally
as a
part
of modern
living-
education and health services are
examples.
Direct transfer
payments
have also
become
practicable, although many
such
payments
are still unrelated to
income
(for example,
the subsidies to
sugar
and farm
products).
As income has become a
widely
usable basis for tax and
expenditure
5When a
commodity producing industry
seeks
governmental
benefits,
it
generally
prefers output
or
entry
restriction because the benefits of direct subsidies are
likely
to
be
dissipated by competition
of firms in the
industry.
Hence the
opposition
of farm
groups
to the Brennan
plan:
the
supply
of
poor
farmers is more elastic than the
supply
of
farm land.
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6 THE
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OF LAW AND ECONOMICS
programs,
we
conjecture
that both the extent of
governmental
activities and
their income redistribution effects
grow.
III. NOTES ON A THEORY
Let us henceforth assume that income is the
strategic
basis for the forma-
tion of
voting
coalitions. The actual income distribution of a
society may
be
presented
as a conventional
frequency distribution,
which is shown in
Figure
I.
In each income interval there is also a
given
number of
possible
voters
(adults).
The number of
possible
voters increases with income: low income
families are often
single persons,
and
high
income families will also contain
more
grown
children and
dependents.
If
every
adult were to
vote,
we would
have a distribution of voters
by
income of the
type (labelled
"100
per
cent
Vote")
illustrated in
Figure
I.
Per cent
of Total
30
-
--Income
27-
24-
/
21
/
18
--Actual Vote
15-
--100% Vote
12
9-
6
-
income
1 2 3 4 5 6 7 8 9 10
Recipients
(Deciles)
FIGURE I
Source: U.S. Bureau of the
Census,
Statistical Abstract of the United
States, Income,
1966 in Table
472,
at 324
(1968).
The actual number of votes cast will differ from the maximum
possible
votes for two reasons. The first is that the dominant coalition can
impose
a
a
variety
of restrictions
upon
voters which decreases the voter
participation
of other income classes. In
particular, upper
income classes increase their
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DIRECTOR'S LAW OF PUBLIC INCOME REDISTRIBUTION 7
share of votes if
they impose literacy requirements, poll taxes,
and residence
requirements (which
affect most the more
migratory persons). Registration
requirements
have
recently
been shown to have a substantial influence
upon
the fraction of
eligible
voters who
actually
vote." The second reason for
differential
voting
is that individuals outside the
majority
coalition will
receive smaller benefits from
voting.
The distribution of actual voters will
be skewed to the
right;
it is labelled "Actual Vote" in
Figure
I.
When
only
excises and real
property
were feasible bases of
taxation,
the
distribution of tax revenues
by
income class would be
relatively regressive,-
perhaps
similar to the tax revenue curve
displayed
in
Figure
II.
The distribu-
tion benefits of
eligible expenditures (education, justice) might
be that shown
in the same
figure;
other
potential public
functions would be excluded be-
cause
they put
a
larger
tax than benefit
upon
the
majority
coalition of voters.
The net redistribution of income
by
income class would be obtained
by
sub-
tracting
the tax distribution from the
expenditure
distribution
(assuming
budget balancing).
There would be as
many possible
income redistribution
curves as there were
possible
combinations of tax and
expenditure programs.
Each income class would of course
prefer
that income redistribution which
benefited it the
most,
and if a
single
income redistribution met this
require-
ment for 51
per
cent of the
voters,
it would be chosen. As a
rule, however,
different fiscal
programs
would be
preferred by
different income
classes,
and
then the
program
to be chosen must
represent
a
compromise.
The
program
displayed
in
Figure II
would be chosen
only
if the area under the votes
curve to the
right
of A contained a
majority,
and if no alternative
program
offered more to some
majority.
At the
present
time both taxes and
expenditures
can be much more
closely
assigned
to
particular
income classes.
Suppose
now that taxes could be made
strictly proportional
to
income,
and
expenditures
consisted of uniform
family
subsidies. Then the difference between the income curve and a uniform curve
(1/10
of subsidies received
by
each income
decile)
would
represent
the
gains
or losses to an income class from recourse to the
political machinery.
Under these restrictive
conditions-proportional
taxation and uniform sub-
sidies-the
gain
to
any
decile income class from a K
per
cent tax would be
readily
calculated:
1. Let its
pre-tax
income be
(siN),
where N is national income.
2. The tax
upon
it would be
KsiN.
6
See
Stanley Kelley, Jr.,
Richard E.
Ayers,
& William G.
Bowen, Registration
and
Voting: Putting Things First,
61 Amer. Pol. Sci. Rev. 359
(1967).
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8 THE
JOURNAL
OF LAW AND ECONOMICS
Per cent
of Total
Expenditures
Votes
Tax Revenue
Income
Redistribution
o A
Income
Recipients
FIGURE II
3. The uniform income class
subsidy
would be one-tenth of the total tax
receipts,
or
KN/10.
4. Hence the
subsidy
to the class would exceed its tax if
KN
>
KsiN
10
or
1
10
Hence all income deciles with less than one-tenth of income would
gain. If
they
contained a
majority
of the
votes, they
would vote for
redistribution,
and if
they
had less than a
majority,
the
government
would not
engage
in
redistributive activities. Since the
gain
to an income decile from redistri-
bution is
KN - -
ssi<
10 10)
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DIRECTOR'S LAW OF PUBLIC INCOME REDISTRIBUTION 9
it rises with the tax rate until K = 1. Absolute
leveling
of income would have
self-defeating
disincentive effects
upon
the
rich,
so that rate of taxation would
be
imposed
which maximized the
present
value of a
perpetual
stream of
redistributions, taking
account of the effects of taxes
upon
the
supply
of
large
incomes. A variant of this scheme is
analyzed
in the mathematical notes
to this
paper.
The fiscal
machinery
of
government
is not limited to such
simple policies
as
proportional
taxation and uniform subsidies. Tax
systems may
be made
regressive
in certain
regions
and
progressive
in
others,
not
only by
income
tax rate schedules but
by
deductions
(costs
of owned
homes)
and
by
excises
on
suitably
chosen commodities.
Expenditures,
as we have
seen,
can be con-
centrated on certain income classes
by subsidizing goods
and services which
primarily
these income classes consume.
The increase in the
flexibility
of taxes and
expenditure programs
works
toward a
larger
role for
government,
and toward
programs
which redistribute
income
increasingly
toward lower income classes. As the amount that can be
collected from
upper
income classes
increases,
and the amount that can be
given directly
to the lower income classes
increases,
the
potential
rewards
from redistribution rise for the lower income classes. In the
long
run the
middle classes
may
have been beneficiaries of this
process
because
they
were
in coalition with the rich in the nineteenth
century,
and are
entering
into
coalition with the
poor today.
MATHEMATICAL NOTES
1. Let families be ranked over the interval
(0,1) by
income. At
any point
x on the
interval,
v(x)
is the number of votes of
family
x
y(x)
is the income of
family
x.
The votes in the successful coalition are
given by
Ve
= -j1
v(x)dx> 1/2, (1)
where
Vt
is the total number of votes.
Let us consider a case in which taxes are levied at a uniform rate t on families outside the
coalition,
and the
receipts
distributed
only
to members of the
majority
coalition. The tax
receipts
will be
T= t
o
y (x)dx + yf(x)dx
.
(2)
Suppose
we add a
small
increment of wealthier families to the coalition:
they
will
possess
v(xI)
(Ax)u
votes.
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10 THE
JOURNAL
OF LAW AND ECONOMICS
Correspondingly
we must subtract an
equal
number of votes from the lower incomes to
maintain a minimum
majority:
v(x0)
(Ax)L
such that
v (x1)
((Ax)u
=
v(xo)
(Ax)L.
(3)
This reconstitution of the coalition will reduce
aggregate
taxes
(and
hence benefits for
the members of the
coalition)
if
t
{y(x1)
(Ax)u
-
y(xo) (Ax)L} < 0,
or, using equation 3,
if
v(xl)
y(xi)
(Ax)u --
y(xo) (Axu) <
0
y
(xo)
or
v(xo) v(x1)
(4)
Y(xo) y(xl)
v(x)
But is a
decreasing
function of x for all
x, so (4)
holds for all x. Hence the success-
y(x)
ful coalition is that for which
xo
=
0,
and
x1
is
given by (1).
This conclusion
ignores
the
question
of
marginal incentives,
to which we turn.
2. The
system
of uniform taxation of the non-members of the coalition founders on the
problem
of
marginal incentive,
that
is,
the families with income above
x1
have after tax
incomes of
(1
-
t) y(x),
x
> x1,
and this
may
be less than
x1.
If one
exempted
y(xl),
the
tax would become
t'[y(x)
-
y(xl)],
where t' is the new rate. The reconstitution of the
coalition
by adding
(Ax)u
and
deleting
(Ax)L
must be such that the limits set
by
disin-
centives be taken into account.
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