Income Inequality (19): What To Do About It?

What to do about income inequality? Assuming of course that you agree that income inequality is a problem. How can we do something about the problem without destroying the incentives behind economic growth (assuming that much of economic growth is driven by financial rewards for effort, creativity, innovation etc. and that taking away resources from wealthy successful people takes away their will and creativity, hence driving down growth and making everyone, including the poor, worse off).

One thing that everyone thinks of is taxation, more precisely <a href="http://progressive taxation: this reduces the income of higher-earning families by a larger percentage than the income of lower earning ones. “Spreading the wealth around”, if you want. This makes incomes more equal in a direct way, but also in an indirect way because the tax revenues can be spend on poverty reduction (unemployment benefits, healthcare or education subsidies etc.). (An inheritance tax can also help, because it promotes social mobility and discourages income inequality that is not the result of economic incentives, and because a lack of social mobility is correlated with income inequality).

The problem, however, is that taxation is hardly ever progressive, even if it looks like it is:

Taxation in affluent countries does little to alter the market distribution of income. The reason is that taxes on income and corporate profits-which are progressively structured, reducing the incomes of high-earning households by a greater percentage than those of low-earning ones-are only part of the tax system. [But] their progressivity tends to be largely offset by the regressivity of payroll and consumption taxes. … Payroll and consumption tax rates usually are “flat”: the rate is the same regardless of individual or household income. Payroll taxes tend to be regressive because they apply to earnings rather than income, and wealthy households tend to get a smaller share of their income from earnings than do most households in the middle of the distribution. Also, payroll taxation often features a cap; in the United States, for instance, earnings above roughly $100,000 are not subject to the social security payroll tax. Consumption taxes apply to spending rather than income. They are regressive because lower-income households by necessity spend more of their income than their higher-income counterparts, so more of their income is subject to the tax. Lane Kenworthy (source)

Redistribution, then, does not occur through or because of the tax system itself, but through the systems of public spending.
Some interesting graphs
here. So it’s the amount of taxes, rather than the system of taxes, that enables governments to redistribute and reduce income inequality.

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1 thought on “Income Inequality (19): What To Do About It?”

  1. (I’m cross-posting this comment here because its relevant here too)

    This is, I believe, one of the biggest, unspoken problems in the US against anything that can be remotely perceived as “socialism.” Naturally, the question arises for any proposed social program: How will we pay for it?

    There *IS* a progressive income tax, but it only applies to the middle class. Above that, tax rates actually decrease. The middle class, certainly since Reagan, is the one to overwhelmingly shoulder the burden, while the rich continue to get tax cuts.

    As long as the rich continue to get such tax cuts, social programs will continue to be met with resistance. But what no one seems to bring up (including so-called “liberals” in the US) is that the rich simply aren’t pitching in– if they were, funding any programs would be no problem whatsoever.

    Between this and the fact that the US spends an inordinate amount of money on what it euphemistically calls “defense,” the poor are screwed, and the middle class cluelessly goes along, making things worse for themselves as well.

    ~josh

    Like

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