By MARK THOMA, The Fiscal Times
October 11, 2011

 

Many economists worry that making societies more equal through income redistribution or other means lowers economic growth. This “big tradeoff” between equality and efficiency, which is supported by comparisons of capitalist and socialist countries, implies that there is a limit to how much redistribution a society should pursue. At some point the tradeoff of more equality for less output – which worsens as we push toward more and more equality – becomes intolerable. However, while the tradeoff is quite unfavorable as we push to extremes, recent experience suggests there is a wide region where the tradeoff is hard to detect. Thus, worries about this tradeoff appear to be overblown.

For example, the Bush tax cuts were justified, in part, by the claim that equity had overshadowed efficiency in tax policy decisions. Taxes on the wealthy and the inefficiencies that come with them were much too high, it was argued, and lowering taxes would cause output to go up enough to lift all boats substantially. Accordingly, the lower end of the income distribution would fare much better after income trickled down than it would under redistributive policy. 

There’s little evidence
that the Bush tax cuts
had any effect at all.


The economy did grow after the Bush tax cuts, but the rate of growth was unremarkable, especially for jobs, and there’s little evidence that they caused large increases in output growth as promised. In fact, there’s little evidence that the Bush tax cuts had any effect at all. The tradeoff simply wasn’t there.

And the tax cuts at the upper end of the income distribution did nothing to correct for the fact that although worker productivity was rising, wages remained flat – a problem that began in the mid 1970s. This was an indication that something was amiss in the mechanism that distributes income to different members of society. Workers were helping to increase the size of the pie, but income did not trickle down as promised and their share of the pie was no larger than before.

This is not the only way in which the distribution of income has become disconnected from productivity. While some argue that those at the top of the income distribution earn every cent they receive, and hence deserve to keep all of it, there is plenty of evidence that the compensation of financial executives, CEOs of major corporations, and others at the top of the pyramid exceeds the value of what they contribute to society by a considerable margin. That holds true even without the financial crisis, but how, exactly, can we justify the extraordinarily high income of this group when the result of their actions was to ruin the economy?

If those at the top of the income distribution receive far more than the value of what they create, and those at lower income levels receive less, then one way to correct this, at least in part, is to increase taxes at the upper end of the income distribution and use the proceeds to protect important social programs that benefit working-class households, programs that are currently threatened by budget deficits. This would help to rectify the mal-distribution of income that is preventing workers from realizing their share of the gains from economic growth.

And there is another reason why taxes on the wealthy should go up. Someone has to pay taxes, and the question is how to distribute the burden among taxpayers. Many believe, and I am one of them, that progressive taxes are the most equitable way to do this. In particular, the guiding principle is that last dollar of taxes paid should cause the same amount of sacrifice for rich and poor alike.

There has been an attempt to make it appear that taxes are mostly paid by the wealthy, e.g. the deceptive claim that half the people pay no taxes is part of this. But taxes are less progressive than before the Bush tax cuts, and when all taxes at all levels of government are taken into account “the U.S. tax system just barely qualifies as progressive.”

We face a choice between cutting key benefits for the middle class and creating an ever more unequal society, or raising taxes on the wealthy to preserve the social programs that lower-income households rely upon. We hear that raising taxes is unfair and that tax increases will harm economic growth. But there’s nothing unfair about correcting the mal-distribution of income that we’ve seen in recent decades, or about making sure the burden from paying taxes is more equitable than it is now. And there’s no reason to fear that economic growth will be lower if taxes are increased. Cutting taxes on the wealthy during the Bush years didn’t stimulate growth and raising taxes back to the levels we’ve had in the past – times when growth was quite robust – won’t have much of an effect either.

The claim that there is a tradeoff between equity and efficiency was a key part of the argument for tax cuts for the wealthy, but the tradeoff didn’t materialize. We sacrificed equity for the false promise of efficiency and growth, and society is now more unequal than at any time since the early part of the last century. It’s time to reverse that mistake.