What if you made $8K a year, but, there was some (small) chance you would clear a million dollars next year? Professional baseball players find themselves in this strange situation. After being hired by a baseball team, players are often required to play in the minor leagues. Then, if that works out, they can move up the major leagues, where salaries are often much, much higher. Very few players make the major leagues from the minor leagues. What is a baseball player to do? How do you live off of $8K a year while waiting for your big payday (if it ever comes)?
On a fascinating Planet Money episode I listened to recently, it described the phenomena of “income pools.” As a minor leaguer in baseball, you find a few of your friends, and you form a pact—if one of you hits it big and goes to the majors, they share some of their income with their less lucky friends still laboring in the minors. It spreads risk, and provides a way that, if your friend makes it big, you share, at least a little, in some of the wealth.
This episode made me think of progressive taxes. Progressive taxes which fund social services and income redistribution can be thought of as a form of risk sharing—as a society, we agree that those that fare less well will benefit from those that strike it rich. The rich are taxed at relatively high rates, and some of that wealth goes to the poor. These baseball income pools are, in some ways, a lot like a progressive tax system.
But, there are many big, and interesting, differences. Here are three:
First, these income pools are created when everyone is poor—you are going to share in the benefit of something that will happen to your friend, or, it will happen to you. New tax regimes are passed when some already have high income, and will forsake more of it if tax rates get steeper. It is not about pooling current risk, but about reallocating from those that at some point got lucky (or worked hard), to those that got unlucky.
Second, with the income pools, you only sign up to be with your friends. There is evidence that people simply don’t want progressive tax rates when it means sharing their income with people that are not like them or that they don’t like. So, if you are allowed to share with your buddies, you are happy to do it.
Finally, with progressive taxes, you will share with people that are much less likely to strike it rich than you were—some that at birth had no chance of ever having a high income. The Planet Money episode highlighted how baseball players that enter into these agreements will generally only do it with players of about their same ability—why would anyone want to share with someone that is much less likely to get to the majors than they are?
I thought thinking through the contrasts between how people voluntarily chose to share their income and how we are forced to do so by our government was useful, and highlighted how it is somewhat structurally impossible to have a progressive tax system that everyone will be happy with in the same way they might be happy entering into some other risk-sharing agreement.
