Stiglitz: Income Inequality Bad for Economy

Via the Joe Stiglitz fake twitter feed:

Famed economist: Income inequality bad for economy, by Andrew Tangel, NorthJersey.com: Joseph Stiglitz ... offered a sobering outlook on Europe's debt crisis...

After his speech Wednesday — part of the Eastern Economic Association speaker series — The Record sat down with Stiglitz to talk about wealth inequality, taxes and how to spur growth in the United States.

Q. Occupy Wall Street has forced income inequality into national discourse. Putting aside the question of whether disparities in income and wealth are fair, what is the impact of income and wealth inequality in this country, and if that gap continues to grow, what could be the economic consequences?

Inequality is bad for growth, stability and efficiency. … Inequality peaked both before the Great Depression and before the Great Recession, and it's not an accident. So basically, when we have a lot of inequality, demand goes down. … All this inequality was offset by creating a bubble. The bubble allowed people to consume more. Now we have the inequality but we don't have a bubble, and that means that we will have persistent, weak demand, and therefore unless we create another bubble it's going to be very difficult for us to get back to full employment.

A lot of the inequality that we have in the United States is created by distortions – excessive financial sector, monopolies like Microsoft … giving the oil companies, mining companies resources at a discount. … These things distort the economy, while they create wealth at the top. So it's not wealth creation – it's wealth redistribution, which makes the size of the pie smaller. ...

Q. We're in a presidential election and there are a lot of economic arguments being made regarding tax and regulatory policies and the labor market. What do you see some of the biggest economic myths — and misunderstandings — permeating today's political discourse in the United States?

The first is that reducing the budget deficit would stimulate the economy by restoring confidence... No evidence that has ever worked. You might call it the austerity myth – that's the most serious one.

The second one is that raising taxes on upper-income individuals will lead them to save less, invest less, will have adverse supply-side effects. Again, no evidence of that.

The third is that lowering [the] corporate income tax rate across the board will stimulate investment in the United States. No evidence of that. … If you want to encourage investment, what you do is lower taxes on firms that invest and you raise taxes on firms that don't invest. You can restructure the taxes to provide incentives to invest.

The answer to the first question makes a point I've been trying to emphasize. If the distribution of income is distorted by monopoly power, political power, and other market failures (e.g. taking advantage of informational asymmetries to sell questionable assets to unsuspecting customers who are reassured by triple A ratings, and so on), then taxing away some of the money and redistributing it to where it would have gone without the distortions is justifiable. And it shouldn't create the sort of distortions to job creation, etc., that the wealthy complain about in response to proposals to raise their taxes. In fact, it's doubtful that taxing the wealthy would have harmful effects of growth even if the distortions to the income distribution were eliminated. But when distortions exist, when taxes are simply returning the distribution of income to the proportions that conservatives argue are optimal, there's no need to even ask the question about whether it will harm growth. It won't. In fact, as Stiglitz notes (and as I have not noted nearly enough when talking about this), the distorted flow of income distorts incentives away from their optimal configuration and thus, if anything, lowers economic growth. I don't think the growth (efficiency) effects are large, for me this is more about equity than efficiency, but conservatives believe these distortions are very important and thus, if growth rather than upward redistribution was really their concern, they'd support efforts to eliminate these distortions. The fact that they don't is telling.

And note another important point. Redistributing the tax burden can do more to promote growth than lowering taxes across the board. The reason is that lowering taxes for everyone gives benefits -- needlessly -- to firms who have no plans to invest, tax cut or not. From an incentive point of view, that's wasteful. Money was spent that did nothing to generate investment. Had the money been used elsewhere, e.g. to promote investment among firms that might actually respond, then we would get more growth per dollar of tax cuts ("bang for the buck" ought to be just as important for tax cuts as it is with government spending). Thus, as Stiglitz says, we can take tax cuts away from firms who are not responding to them and redirect them elsewhere. That gives us the desired increase in investment and growth without increasing the deficit, and hence reduces the pressure to make cuts in social programs or to raise taxes elsewhere to compensate for all the money wasted on tax cuts given to firms who will not increase investment in response. Giving tax cuts to firms who will not react to them simply redistributes income without producing the desired outcome on economic growth. Once again, if anything this type of redistribution lowers efficiency and growth, the opposite of what is intended.