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Specifically, most Americans subscribe to the view that market-determined gaps between the rich and poor should be softened by government. The rich should be taxed, and the poor should be helped. But how much should the government intervene? One common argument is that there is a trade-off between efficiency and fairness. If the rich are taxed and the poor are helped through transfers, the hard work of the rich is punished and the idleness of the poor is rewarded. The rich cut back on their effort—for example, by not opening a new business—while the poor use their windfall to support their leisure, for example by not taking an available job. The result, say the critics of income redistribution, is that society squanders much more than $1 of income for each $1 of government help that actually reaches the poor. Redistribution, they believe, should be severely limited, used to address only the most extreme problems of poverty and hunger.

Other societies, such as the Scandinavian social democracies, have for a long time taken a very different view. They believe that even extensive redistribution can and should be carried out by government and that such a redistribution can be accomplished with very little inefficiency. The rich will continue to work hard even if they are taxed relatively heavily, and the poor will use the government help to raise their productivity. Economic theory indeed supports the view that high tax rates can actually spur, rather than hinder, work effort, since more rather than less work effort is then needed to reach a specific target level of income (for example, to buy a house or to cover a tuition payment).

Let me underscore a basic point that is generally overlooked in the heated U.S. debate on this issue: in many circumstances, there is no trade-off at all between efficiency and equity because the two goals actually go hand in hand. Promoting fairness also promotes efficiency. Here’s how.

In many cases, help for the poor is not simply an income transfer used for short-run consumption but is a government benefit that enables poor households to raise their long-term productivity. Some of the key government programs for poor households include help for nutrition of mothers and young children; preschool; college tuition; and job training. Each of these is a government-supported investment in “human capital” and specifically a way for a poor household to raise its long-term productivity. Taxing the rich to help the poor can then mean cutting lavish consumption spending by the rich to support high-return human investments by the poor. The outcome is not only fairer but also more efficient.

The need for public financing of education has been recognized by virtually all economists since Adam Smith, including the strong promoters of free markets such as Friedrich Hayek and Milton Friedman. They’ve understood that markets alone will not educate our young people, at least not enough of them. The situation has become even more serious today. With rising costs of education, the poor are likely to be left behind, and trapped in poverty, unless the government steps forward to help finance a quality education for all.14

Finding the Balance of Markets and Government

The proper balance between markets and government has been at the center of debate for generations, going back to Adam Smith’s explanation of self-organizing markets. A fierce debate has been under way for more than two centuries. Here are five of my own conclusions regarding this debate, which I believe to be relevant for our times.

First, in productive sectors of many producers and consumers, and therefore where strong market competition applies, we should rely on market forces. This is Hayek’s position, and it’s a good one. Markets have several desirable attributes. They are decentralized, voluntary, and do not require the very difficult work of forging cooperation among a large number of people. They can cater to the distinct tastes of individual