It can be figured that a wage cap could have some noticeable short term effects - mainly, those who are higher paid will not receive as much money anymore, meaning less spending by the richest in the economy (who also happen to own a large portion of the economy's wealth) and more economic downturn for companies.

However, the market could normalize after this as the money earnt by a nation's richest would eventually be more evenly distributed amongst others, hence they would spend more, canceling the downturn.

My question is how will a wage cap (a limit on the amount of income that can be possibly earnt in a year) have negative long term effects that will not be countered by more equal spending in the economy, as provided in the example?

Mainly, I am interested in how will this affect the purpose of money. Would the power of money possibly be restricted in a noticeable way that leads to negative effects in the long-term? Would there also be other negative effects, both on the macroeconomic and microeconomic scale, that would last in the long-term and prove difficult to counter?

Sources, links and further reading is welcome. Thank you in advance.

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However, the market could normalize after this as the money earnt by a nation's richest would eventually be more evenly distributed amongst others, hence they would spend more, canceling the downturn.

Wage cap is not an redistribution measure. It’s an measure aimed at reducing inequality but without any direct redistribution.

For example, suppose you have Peter and Paul, Peter earns 10000\$ per month and Paul 1000\$ per month. If there is wage cap 5000\$, Peter will earn 5000\$ and Paul is still earning only 1000\$. Hence there is no direct redistribution effect even though inequality is now lower.

So there will not necessarily be any more spending in an economy. That assumption is completely false and would hold for income tax that redistribute money from rich to poor but not for wage cap. In fact most likely there will be less spending in the economy as result of wage cap.

Regarding other long term effects of wage cap, it would severely depress the labor supply of people to whom it applies to. Wage cap is de facto equivalent of confiscatory tax that confiscates any income above certain level, but it is even worse as government does not even get any revenue, from it. If a person does not earn any income for their labor above certain level they will have no incentive to work anymore (aside from maybe the fact that they enjoy their work). Hence their labor supply will be depressed. They will spend less time at work and more time enjoying some leisure activities.

This can have serious impact on economy as usually people who earn more in market based economies are those people who are more productive. Highly skilled doctors, managers, scientists etc, decreasing overall productivity of the economy. Moreover, such measure would create a permanent supply shock (as long as it would be in effect) permanently lowering the level of GDP and hence also the material welfare of people in given country.

It could also impact the growth of the economy, as endogenous theory of economic growth says that human capital formation can be very important driver of economic growth and since people tend to earn more the more human capital they have this would depress the human capital formation for the very brightest who would be affect by such a measure.

Also as a side note, I don’t really know any public economists who would approve of wage cap. The reason for that is that in fact if you care about redistribution you want as many people with high incomes as possible so then you can tax their incomes and raise the welfare of the poor through redistribution.

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  • $\begingroup$ The question is what happens to the other $5000 that isn't going to Peter? $\endgroup$ – user253751 Mar 16 at 13:05
  • $\begingroup$ @user253751 it’s not created. In market economy people are approximately paid their marginal product (there might be some deviations depending on market parameters), meaning if Peter earns 1000 it is because his marginal productivity per month is 1000$, imposing wage cap on Paul does not increase Peters productivity (now assuming away for a second potential general equilibrium effects that could be in play which could go either way). People earn their wage because they create new value worth their wage not because there is some pie that’s being sliced up - the 5000 is not anymore being created $\endgroup$ – 1muflon1 Mar 16 at 13:15
  • $\begingroup$ As if wage cap is imposed Peter is no longer going to supply so much labor to the market to create 10000$ value but only enough to create 5000$ value because that’s his new wage (as mentioned in the answer there could be some psychological effects maybe Peter loves his job, but these are small enough to be assumed away), meaning whereas previously economy was producing 11000$ of value now it will be producing only 6000$ of value 1000$ will go to Paul and 5000 to Peter (in previous comment I accidentally interchange the names sorry for that) $\endgroup$ – 1muflon1 Mar 16 at 13:20
  • $\begingroup$ Several things seem possible. One of them is that Peter works 20 hours a week instead of 40. Another is that Peter's wage is now half but he still works 40 hours a week and his employers has \$5000 less expenses. If Peter is an employer, he might not choose to stop growing his company just because his profits reach \$5000/week, because there are other things he would gain besides money (e.g. fame). If Peter is an employer, he might hire a family member or friend to do nothing for an extra \$5000/week. All sorts of possibilities, which is why you need to convince us your one is right $\endgroup$ – user253751 Mar 16 at 13:20
  • $\begingroup$ If Peter's field gets a reputation of "you only need to work 20 hours" it might encourage more people to train in that field, too. $\endgroup$ – user253751 Mar 16 at 13:21

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