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Sunday, June 25, 2006

And Justice for All

Following up on the previous post, here are Greg Mankiw's views on the existence of, the source of, and solutions to growing income inequality in the U.S.:

On Inequality, by Greg Mankiw: A student asks a broad question:

I was wondering if you could offer your views on income inequality.

Let me offer a few observations as broad as the question:

1. There is little doubt that U.S. income inequality has been increasing for the past three decades. (The trend in world inequality is very different.) Most economists who study the topic attribute the trend primarily to changes in technology that reward skilled workers relative to unskilled workers. Education and other skills are more valuable now than they were in the past.

2. Reasonable people can disagree about how much the government should redistribute income. Part of the disagreement is economic: for example, how large are the elasticities that determine tax distortions? Part of the disagreement is philosophical: for example, is taking money from high-wage individuals to give it to low-wage individuals a way to ameliorate the injustices inherent in a market economy or a form of government-sanctioned theft? Economists can help with the economic part of the disagreement, but we have no comparative advantage to help with the philosophical part.

3. However much redistribution we choose, the best way to accomplish it is by a progressive system of taxes and transfers. Economists sometimes call this a negative income tax, because low-income individuals pay a "negative" tax. The current progressive income tax together with the Earned Income Tax Credit is close to being an example (although the EITC has a variety of conditions that a pure negative income tax would not have). Wikipedia reports the following... "...the EITC is one of the largest anti-poverty tools in the United States, and enjoys broad bipartisan support."

4. Ideally, I would use consumption, rather than income, as the tax base for purposes of raising revenue and redistribution. The benefit of consumption taxes over income taxes is that they do not distort the intertemporal allocation of consumption. A variety of economists have proposed ways to implement a progressive consumption tax. For example, the Hall and Rabushka flat tax is progressive in average tax rates; the Bradford X-tax is similar but even more progressive.

5. Having achieved the desired degree of redistribution with a system of taxes and transfers, policymakers should focus on economic efficiency when setting most other policies. That is, policy regarding international trade, rent control, minimum wages, health care, housing and so on should, in my view, aim to make the economic pie as large as possible. Although these other policies affect the size of different slices, they are inefficient and poorly targeted instruments for purposes of redistribution. To the extent that we choose to redistribute income, we should use the best tools we have for that purpose (see points 3 and 4).

Greg and I aren't that far apart on the economic issues, e.g. when I talk about market failures that is the same as his point about efficiency. I've also noted previously that consumption taxes are generally more efficient than income taxes, but the politics that come with them are more difficult since consumption taxes generally require ex-post income redistribution policies to make them progressive.

On the economics, I suspect where we would differ is on how pervasive market failures are and how effective government can be when it intervenes to overcome them. For example, I would claim that market failures make the private provision of health and social insurance less efficient than government regulated provision, but I suspect he would not, at least not to the same degree.

On the philosophical issue, he doesn' say how much income redistribution he favors, but as I said my view, broadly stated, is that it ought to be sufficient to overcome injustices and equalize opportunity, but there are those on the left who would go further than this in terms of equalizing outcomes.

Finally, I should note that Krugman would disagree strongly with the claim in point 1 that the main cause of growing inequality is an increase in the skill-based wage premium. See Graduates versus Oligarchs. This is important because the solution to income inequality depends upon whether it is a reward to education, or a consequence of government policy. Quoting Krugman:

The notion that it's all about returns to education suggests that nobody is to blame for rising inequality, that it's just a case of supply and demand at work. And it also suggests that the way to mitigate inequality is to improve our educational system — and better education is a value to which just about every politician in America pays at least lip service.

The idea that we have a rising oligarchy is much more disturbing. It suggests that the growth of inequality may have as much to do with power relations as it does with market forces. Unfortunately, that's the real story.

I suspect the need to intervene to overcome injustices associated with government policy and changing power relations is another area where Greg and I would disagree.

    Posted by on Sunday, June 25, 2006 at 10:11 AM in Economics, Income Distribution, Policy, Politics | Permalink  TrackBack (0)  Comments (54)

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