Wednesday, February 27, 2013
This article examines some basic issues related to taxing and spending policies and how different distributions of income or wealth in a society may influence these basic choices. It seeks to provide a guide to addressing tax and spending policies in an era of increasing inequality. This is challenging because it requires a good understanding of inequality and economic mobility, the changing role of taxes and government social spending, the constraints on policy options, and the possible misconceptions that may influence tax and spending policies.
Inequality in the United States has increased dramatically over the last 30 years, whether measured before or after government tax and transfer policies. Perhaps even more troubling than the rise in inequality may be the decline in economic mobility. The American dream of working hard to get ahead may be more fiction than fact.
The same thirty-year period during which inequality has increased and economic mobility has decreased has seen major changes in fiscal policy. Tax law changes have altered the relative tax rates, the relative revenue contributions from different tax instruments, and the tax burdens of different income groups. Government spending on social programs has increased substantially, but perhaps not in ways one might expect. The United States likely has a smaller percentage of government social spending going to the needy than other developed countries. An increasingly larger percentage of social spending is directed at the elderly (without regard to need) and through tax subsidies to the upper half of the income distribution rather than those at the bottom of the income distribution or to low and middle income single-parent households with children.
If one really wants to use fiscal policy to reduce inequality and poverty or increase economic mobility, one needs a new approach. The first step is to identify clearly the relative priorities among reducing inequality, reducing poverty, and increasing economic mobility. Tax and spending policies will differ depending on the weight given each of these objectives, and in a world of relatively limited resources, the government needs to make difficult choices. One key insight is that it may be useful to stop thinking about increasing the income tax burden on the wealthy as the only, or perhaps even the primary, way to increase social spending programs. The U.S. may need less progressive (or even regressive) taxes to fund more progressive spending programs.