Taxes and Transfers Have Become Less Effective at Reducing Inequality

November 26th, 2012 at 11:39 pm

I’m working on a paper based on a model of an economy with high and growing levels of income and wealth inequality.  I’ll say more about it later, but in coming days, time permitting, I’ll post snippets that might be of interest.  For example, one prediction generated by this model is that policymakers advocate on behalf of the beneficiaries of inequality for regressive changes in taxes and transfers.  They inveigh against both progressive taxation and social insurance.

Any of that ring a bell??

So here’s a figure, using very comprehensive CBO income data to show that, in fact, taxes and transfers have become less of a bulwark against rising inequality.  Each bar in the figure shows the percent increase in the Gini Index (a measure of income concentration) under three different definitions of income.  Using just market income, the Gini rose 23%, 1979-2007.  Adding government transfers, the Gini actually rose more—by 26%.  This may seem a bit confusing to those who recognize that transfers are equalizing, but the source of such confusion is the conflation of levels versus changes.  Of course, the Gini index is lower at any point in time after transfers (and taxes), but less so over time.  Thus, both transfers and taxes have become less effective in reducing market based inequality, a trend the model would predict.

Source: CBO

Here is a list of other policy developments predicted by the model:

  • Regressive tax changes
  • Shift from labor to capital incomes
  • Deregulate financial markets
  • Privatize social insurance
  • Eroding labor standards (min wage, labor protections)
  • Diminished unionization; opposition to collective bargaining
  • Pro outsourcing
  • Monetary policy favoring low inflation over full employment
  • Diminished gov’t commitment to education
  • Eroding safety net
  • Anti-Keynesianism; pro austerity
  • Let-it-rip campaign finance
  • Smaller gov’t outlays as share of GDP

Jeez…that kinda reads like I’ve got my thumb on the scale…but you’ll see—these pop right out of a model where inequality diverts not just growth, but opportunity, mobility, and political clout from middle and low-income households.

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6 comments in reply to "Taxes and Transfers Have Become Less Effective at Reducing Inequality"

  1. Ken Houghton says:

    Dang, man, you’ve created a model that comes close to mimicking reality.

    Time to find another field. (And I wish I were joking.)

  2. D. C. Sessions says:

    How would you propose to falsify that model?

    • Jared Bernstein says:

      Like any model–if it’s predictions didn’t match reality. And, in fact, some don’t. EG, there’s an argument that $ in politics is less influential than the model predicts. Also, declining share of gov’t spending comes out of the model–while that’s aspirational to many, it has yet to occur. So, the model is far from perfect.

      • Nick Batzdorf says:

        I sure hope that the outcome of this election doesn’t sweep the influence of $ in politics under the rug!

        Imagine a model in which politicians weren’t constantly worried about raising money for campaigns. That would make solutions to literally all our problems a lot closer, whether they’re local, global, or…I hesitate to use the word “existential,” but it’s probably not hyperbole to categorize climate change and the other ecological issues we’re facing that way.

        (This is why I volunteer at – the first baby step is full disclosure in political advertising.)

  3. Kenneth D. Franks says:

    Many models are not perfect however that doesn’t mean that they don’t serve the purpose of trying to explain complicated realities.

  4. Pasquino says:

    Something significant has also happened during this period: Baby Boomers have neared and reached retirement age, distorting the national mindset in ways no one is commenting on. Notably this: as Boomers have become more and more obsessed with their retirement accounts their loyalties have shifted from “Working for a Living” to “Owning for a Living”, with all that that entails, including perhaps voting like David Koch or his rich brother. They vote their stocks. This shift in loyalties has a knock on effect in other areas and demographics too. It might be worth adding (would be well worth adding) this realization to the mixture of cause and effect that economists measure. We don’t want to assume current trends are correct, rational and durable, because assuming that makes events self-validating, despite factors, such as the one I am asserting, which are not being noticed and may be only momentarily weighted.