Some of you may have seen this when it came out, two years ago. I missed it, so I bring it to you now.
From the QJE, August 2005, Vol. 120, No. 3, Pages 963-1002....(Luttmer's personal link to a PDF of the paper)
"Neighbors as Negatives: Relative Earnings and Well-Being," Erzo F. P. Luttmer,
This paper investigates whether individuals feel worse off when others around them earn more. In other words, do people care about relative position, and does "lagging behind the Joneses" diminish well-being? To answer this question, I match individual-level data containing various indicators of well-being to information about local average earnings. I find that, controlling for an individual's own income, higher earnings of neighbors are associated with lower levels of self-reported happiness. The data's panel nature and rich set of measures of well-being and behavior indicate that this association is not driven by selection or by changes in the way people define happiness. There is suggestive evidence that the negative effect of increases in neighbors' earnings on own well-being is most likely caused by interpersonal preferences, that is, people having utility functions that depend on relative consumption in addition to absolute consumption.
This is an old problem, but the empirical work is quite interesting. Here's the problem: consider two societies.....each has exactly two classes of people, the numerous poor and small number of rich. Assume also that the numbers, and proportions, are identical in the two societies. The two are:
Society Alpha, where the poor receive $20k income per year, and the rich receive $40k income per year.
Society Beta, where the poor receive $25k income per year, and the rich receive $120k income per year.
Society Beta is better, right? First, by the Pareto criterion, EVERYONE is better off in Beta than in Alpha. Second, one could always redistribute, and take some from the rich in Beta, and make the poor even better off.
This paper would seem to raise questions about the first claim. Pareto comparisons based on wealth have nothing to do with welfare. The poor in Beta are MUCH worse off, because the disparity between rich and poor is greater. And there may be no means of redistributing enough to make this difference go away, unless you do away with the rich entirely.
Oh, society of frailty, thy name is growth.
(Nod to KL, who actually believes in redistribution, but isn't envious of the rich. At least not much)