Thursday, April 24, 2014
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Which Policies Reduce Income Inequality?

BERKELEY – US President Barack Obama recently declared that growing income inequality and the inequality of opportunity that it creates are the defining challenges now facing America. These problems have risen to the top of the political agenda in the United States, but they are not uniquely American problems.

Income inequality began to widen in the US in the late 1970’s, and the trend spread to Europe by the late 1980’s, affecting even countries with long egalitarian traditions by the start of the new century. On the eve of the Great Recession of 2008-2009, income inequality had reached all-time highs in the US and most developed countries.

The recession and the painfully slow recovery have caused conditions everywhere to worsen, especially for children and young people entering the labor market. The fact that widening income inequality is a common feature of developed economies suggests common causes which are still not well understood.

It is widely believed that America’s income distribution is the most unequal among developed economies; but reality is more complicated. Income can be measured in two ways: market income before taxes and transfer payments, and disposable income after taxes and transfer payments. Surprisingly, inequality of market income before taxes and transfer payments in the US is similar to that in many other developed countries, including those with egalitarian reputations like Sweden and Norway. Britain and even Germany have higher inequality of income before taxes and transfers than the US.

Among developed countries, the US does have the most unequal distribution of disposable income after taxes and transfer payments. That is not because the US has the least progressive tax system; indeed, its tax system is considerably more progressive than those of most European countries, Canada, and Australia, all of which rely on regressive value-added taxes as an important source of revenue.

But, among developed countries, the US has the least generous and progressive transfer system. The US spends a much smaller share of GDP on family-assistance programs – including cash transfers, tax breaks, and direct government services – than its developed-country counterparts, where reliance on regressive consumption taxes to fund progressive transfer programs has kept income inequality significantly lower.

Over the last 30 years, US economic policy aggravated rather than ameliorated income inequality. Both taxes and transfers became less progressive as market-income inequality widened. Indeed, according to a recent study, the decline in tax and transfer progressivity accounts for about 30% of the growth in post-tax-and-transfer income inequality in the US during this period.

The US needs a more progressive and redistributive tax and transfer system to combat rising inequality in market incomes. But this is unlikely, at least in the near term. Republicans are implacably opposed to increases in social-welfare programs and higher taxes on the wealthy to finance them. And there is bipartisan opposition to a value-added tax, with Democrats fearing its regressive consequences and Republicans dreading its revenue-generating effectiveness.

To combat market-income inequality, the US also needs faster economic growth to boost the pace of job creation and reduce unemployment. The economy has been growing at less than half the rate that it did in previous recoveries, and the labor market has improved at an agonizingly slow pace.

Indeed, the unemployment rate, at 7%, remains elevated, despite a record-low labor-force participation rate. About four million workers have dropped out of the labor force since the Great Recession began. Roughly eight million are working part-time, because they cannot find a full-time position.

Prolonged labor-market slack means falling real wages for most workers, with the negative effect growing as one moves down the wage distribution. The result is greater market-income inequality. From 2007 to 2012, US real hourly wages fell for 70% of the wage distribution, with larger losses for those holding lower-wage jobs. By contrast, real wages increased, albeit at a much slower pace than before the recession, for those in the top 30% of the wage distribution.

In his inequality speech, Obama reiterated several proposals to accelerate growth: increasing exports, reforming the corporate tax code, and investing more in infrastructure, R&D, and education. These proposals are both growth-enhancing and equity-enhancing. Yet Congressional approval is unlikely, and overall fiscal policy remains strongly contractionary, reducing growth by about 1.5 percentage points this year.

Obama also called for an increase in the minimum wage to combat income inequality. Here, prospects for Congressional approval look more promising, owing to strong voter support, with surveys showing that large majorities of Democratic, independent, and Republican voters support an increase.

Adjusted for inflation, today’s federal minimum wage of $7.25 per hour is 23% lower than it was in 1968. If it had kept up with inflation and with average productivity growth, it would be $25 per hour. At the current minimum wage, a worker employed full-time for a full year earns only $15,080 – 19% below the poverty line for a family of three.

According to the OECD, the US has the second-highest relative poverty rate (the share of the population that earns less than half of the national median income) among developed countries. Recent research suggests that an increase in the minimum wage would have a powerful positive effect, with a 10% increase cutting the poverty rate by 2%.

Indeed, about 30 million workers would benefit from an increase in the minimum wage to $10.10 per hour, as proposed by Congressional Democrats. Of these, 88% would be at least 20 years old (with an average age of 35); 55% would be working full-time; 56% would be female, and more than 28% would be parents. Putting more income into their hands would not only reduce poverty; it would stimulate consumer spending at a time when inadequate demand continues to impede recovery and job creation.

President Obama has made significant progress combating income inequality. Under his leadership, the federal income tax system has become more progressive, and Obamacare is the most progressive social-insurance program since Medicare and Medicaid began in 1965. But there is far more to do. Raising the minimum wage is the right next step.

Read more from "Unequal at Any Speed?"

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  1. CommentedBruce Steinback

    One complaint (or at least question):
    The studies I've seen on progressivity of tax systems just do a Federal comparison. The problem with that is that the state and local taxes here in the US are rather regressive. I suspect that if you include them, the overall taxes in the US aren't much if any more progressive than Europe.

  2. CommentedPhyllis Anderson

    Wonderful idea, Dr. Tyson. I wonder how this goal is furthered by your longtime and continuing leadership of the lobbying effort by a coalition of large corporations to evade corporate taxation by repatriating their billions in profits at the progressive and fair rate of 5 percent? Will that make inequality worse or better. If you'd like to challenge the view that our current tax system is already too regressive, I don't think you can push to make it shapely more recessive.

  3. CommentedJoshua Ioji Konov

    The Inequality could be easily connected to the ongoing Globalization and rising Productivity well accelerated in the last 25 years. The inequality also between Large Transnational Corporations and Small Businesses and Investors has gone alone wealth inequality. The question is if it is anyway but through higher taxation could reduce it? Well, economic agents such as weak business laws, environmental and consumer protection laws, e.g. that accelerate the market insecurity and finally promote mostly Large Businesses and Investors if marginalized reducing their superiority than most likely could improve the Small Businesses and Investors, and the over all wealth inequality.

  4. CommentedRonald Abate

    What is left out of all the statistics is the cash economy which alive and well. It's well known among the non-intellectual class that a high proportion of those on government assistance work only for cash. The underground economy is variously estimated at 10% to 15% of the reported economy. That's a minimum of $1.5 trillion with a "T", that is not counted in the inequality figures. The advantage of the VAT is that it captures a large part of this underground economy.

    I don't know what the answer is. Taxing the rich is, in my opinion, counter productive as they will use their influence to gain all manner of tax loopholes, regulatory capture, government subsidy and other means to claw back a large portion of any incremental tax. So the government gets bigger, taxes and regulations get more complicated and the big losers are those who are working hard to raise a family and save for retirement on a good but not great salary.

    Frankly, the U.S. should be doing a lot better economically, but that's not going to happen because of the looney Left and Right.

    Actually, the U.S. should walk away with top place in the 21st Century as we have all the ingredients to make it happen,but it will not happen.
    1.) We are a large, sparsely populated country that can easily support a population double or triple what we have now. However, we need immigration that will add value not consume value. This will not happen because the Democrats need poor people to increase their base and the Republicans are anti-immigration.
    2>) With what is still the best university system in the world, and the English language, which every bright young adult from every non-English speaking country learns in order to participate in the global economy, we should have a lock on bringing to this country the world's "best and brightest" to study and stay. It will never happen for the reasons written above.
    3.) It is now pretty clear that we have enormous reserves of hydrocarbons, which will continue to be the cheapest form of energy for decades to come. This should make us extremely competitive economically and lower our cost of living versus Europe, China, Japan and all those other countries not so blessed. I certainly am all in favor of producing these hydrocarbons in as an environmentally friendly manner as possible, which just this aspect of our hydrocarbon treasure should create thousands of high paying jobs. No it will never happen, partly because of the wholly unproven theory, no not theory, it does not even rise to the level of a theory (a theory has to falsifiable), it's more a speculation, about dangerous anthropogenic global warming "CAGW". There was a good recent discussion about CAGW being a "wicked problem" that we hardly fully understand. It can be found at Econtalk.org and its between Russ Robert, economic professor at George Mason and Dr. Judith Curry, professor of atmospheric studies at Georgia Tech. CAGW is just part of the problem. The other problem is there is a powerful lobby of wealthy people who care less about economic growth and jobs for people not too well off who oppose any development, but especially development that consumes natural resources. It will never happen.
    I could go on why the 21 St Century should be an American Century benefitting all Americans, but especially the less educated and the less well off but it will never happen.

  5. CommentedCraig Busse

    I have no confidence that general welfare benefits from price controls, which is what a minimum wage is. A somewhat better case can be made for more progressive taxation and welfare benefits, but what I would really like to try first is a light but broad financial transaction tax to better finance the government while countering the excessive financialization of the economy which I believe has been a major cause of unwarranted inequality.

  6. CommentedRoger McKinney

    Good economists look to the long run. These are all short run solutions that do long run harm. The socialist redistribution of Europe is destroying the continent's economy. Wise nations have begun rolling back much of their socialism. The last place we need to look for advice on inequality is Europe.

    Besides, comparing small homogenous nations with the US is bad statistics. We need to compare all of Europe with the US, and not just averages of inequality across European countries.
    Fed inflationary policies cause growing inequality. The rich get new money first and can buy assets before prices rise. The working poor get the new money last, after prices have risen.
    Fed credit expansion causes the boom and bust cycle and the working poor get hurt the most because they lose jobs the most and their wages increase the least.

  7. CommentedJon Roland

    Another effect of raising the minimum wage is to drive the less-skilled into part-time work for cash, like mowing lawns, where they actually net much less than minimum wage and less than they were making before the minimum was raised.

    But of course labor leaders don't care. This is a way to sell their members on supporting them with union jobs that pay well. They have found the members to be ignorant and gullible enough to buy the Big Lie they are telling.

  8. CommentedJon Roland

    The main effects of raising the minimum wage is to cause the layoffs of those whose work is worth less, which it then either left undone or spread among other workers, for a net reduction in productivity, higher production costs, lower return on investment, and reduced sales and competitiveness with foreign suppliers. That causes a reduction in investment in the creation of law-paying jobs, and perhaps an increase of investment in machines to do the work.

    No, the real solution would be to find ways to pay the poor to do productive things that are within their abilities to yield products and services that people are willing to pay for. Raising the minimum wage is like raising global temperatures, something that accelerates economic decline until it reaches a tipping point of a runaway collapse that brings down civilization.

  9. CommentedMr Econotarian

    Why should the minimum wage track with average productivity? Shouldn't it track with minimum productivity?

    Moreover only a small percent of the poor male minimum wage in the US. A third of minimum wage earners are teenagers, some with household incomes of $100,000 or more.

    People who are poor in the US tend to be poor because of not working enough hours, rather than making low hourly wages. Many of these are working single mothers who have trouble obtaining affordable child care (and child care is too expensive due to regulations).

    The problem the author dances around is that the US taxes too much for spending on old people (often well to do ones) instead of spending on actual poor people.

  10. CommentedLuc Lapointe

    Let's just assume that what you wrote make sense - (or what the OECD wrote) - you would assume that there is a lot of discretionary spending in the pocket of consumers that would be better used paying more for a Big Mac. Higher minimum wages would just take more money out of the pocket of poor people (or about to be poor) and give them back a small portion. Owners of McDonald's or similar low wage focused industry/corporations would simply raise the price or cut into other spending (not Executive salaries) so that they can generate the same profit for shareholders. At the end of the day...corporations do not create money ..they are a very complex system of financial engineering that takes money out of the system t create a few jobs that keep people at the edge of poverty. Unemployment levels will remain somewhat HIGH for many years to come ...any decrease in unemployment would create pressure on salaries and no one can afford it right now.

    Not sure who came up with the idea that higher minimum salary hikes would do any good...when the economy is rolling full steam "maybe" but when discretionary spending is this low...it doesn't do anything to anyone...if company could not raise the price due to elasticity -- they would layoff more people...it just doesn't add up!

    Saludos....Luc Lapointe

  11. CommentedJon Roland

    It is not "income" that is the appropriate measure of "inequality", but "consumption". There is little correlation between the two. Most of those at the upper end of the "income" scale don't personally consume much more than those at the lower end. Most of what is counted as their "income" are data moved around in computers that just gets re-invested and is never used to buy any consumer products or services.

    The important thing to consider is whether people reach a consumption floor, provided that they make an effort and don't do foolish things. But there will always be some who deserve to be poor, and nothing should be done to help those.

    Now there is a problem with that surplus income being used to buy political influence that distorts the market, or for speculation rather than investment in new technology and capital production. That can actually be a threat to society.

  12. CommentedG. A. Pakela

    Increasing the minimum wage will have no net effect on inequality. That is because after the increase, at the margin there will be less employment for minimum wage workers. The most productive minimum wage empl0yees that remain after the increase will benefit, but those that are left out by lack of opportunity will suffer. Minimum wage jobs are for most an entry level job from which to launch their career as they gain more experience, skills and education. If a "breadwinner" has to rely on a minimum wage job for employment, it is better social policy to supplement that income with outright cash grants rather than create an involuntary army of the unemployed.

  13. CommentedProcyon Mukherjee

    The article raises more questions than answers. First of all before delving into distributional questions and transfer payments, the core of the issue revolves around excess supply of low skilled workers, which stymies the pace of low-wage growth, which by all means have gone down to levels five decades back. On the other hand the high skilled wage growth had tripled for the same period in question. Why do we not incentivize immigration of high skilled workers into America and stop or mellow down the same for the low skilled ones? The former would create just the ground for high skilled wages to drop and the latter would create just the gap needed to get the low skilled wage back on track. The question is whether this is politically tenable?

    The second question is when we see the capital formation through productivity improvements in the last decades, we also notice the increase of outsourcing jobs in the less-skilled sector, which effectively means that capital is replacing labor or to put it differently, we are importing labor by exporting capital.

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