Thursday, October 1, 2015

Soaking the Rich With Higher Income Taxes Won't Help with Income Inequality

There are those in the United States who have so much wealth that they don't know what to do with it while there are others who have to work hard to earn an honest living or even survive from day-to-day. The sort of outlandishness that is exhibited by the exceptionally wealthy comes off as unfair to many. The latest Gallup poll on the subject shows that 52 percent support redistributing wealth by heavily taxing the rich. Bernie Sanders is making it one of the cornerstones of his presidential campaign. It is such a part of Sander's campaign that he stated that he would love to soak the rich with a marginal tax rate of 90 percent because honestly, how else do you expect him to pay for his costly, insolvent programs that would most probably do the exact opposite that he intends?

As proponents of this line of thought would like to think, "If we could simply tax the rich and spread some of that money around, we could make a huge difference in the lives of so many Americans." To quote Penn Jillette, "Voting for our government to use guns to give money to help poor and suffering people is immoral, self-righteous, bullying laziness." But let's set aside moral or philosophical qualms for now. Let's also set aside how this would increase revenue (see herehere, and here), how it would affect economic growth, decrease work incentives for the rich, create new reasons to evade taxes, or how the welfare system creates disincentives to work. I would like to answer the question of whether increasing income taxes on the wealthy would solve income inequality woes.

Taking from Peter to give to Paul seems intuitively sound at first glance. The government takes money from the rich to give to the poor. The poor take that money, purchase goods and services that they desperately need, and circulate that money into the economy. This would give the poor a great economic boost, and subsequently pull the poor out of poverty. As nice as that might sound, there has been some recently published research to counter that notion.

Earlier this week, the Brookings Institution released a paper entitled "Would a significant increase in the top income tax rate substantially alter income inequality?" Let's keep in mind that the Brookings Institution is not a conservative think-tank or a proponent of the free market system. The Brookings Institution tends to be more centrist (although sometimes more Left-of-center than it likes to admit), and comments often enough on the importance of dealing with income inequality. It came as a surprise to some, including one of the researchers of the paper, that soaking the rich with a higher marginal income tax rate would do so little to help with income inequality. How so?

[As a side note, it also came as a shock to these same researchers that increasing access to college education would also have minimal effects on income inequality.]

Currently, the top individual income tax rate is at 39.6 percent. The researchers at the Brookings Institution ran a microsimulation to see what would happen if that tax rate were raised to 50 percent. To find out how this would affect income inequality, they took a look at the effects it would have on the Gini coefficient. Essentially, the Gini coefficient is a 0 to 1 scale measuring the dispersion of income distribution in a given nation (further explanation is here). The main thing that surprised me was that the Brookings Institution had the pre-tax Gini coefficient at 0.61 because looking at data for the World Bank, the CIA, United Nations, and the OECD, it is considered lower than 0.61.

However, let's assume that the Gini coefficient is that high. Under the current law, government redistribution lowers that to 0.574. Assuming that the tax revenue would be an explicit redistribution of wealth to the lowest quintile, the difference between current law and raising the marginal income tax to 50 percent would change the Gini coefficient to 0.571 (Table 2). That is a measly 0.003 points on the Gini scale, which is only a 0.52 percent change!

Raising the marginal tax rate to soak the rich is yet another example of how misguided good intentions can be. Increasing the marginal income tax might help to increase government revenues (only to a certain point before the reality of the Laffer curve kicks in), but decreasing income inequality by an amount of any significance is certainly not a reason to do so. The poor are not poor because the rich are rich, and trying to redistribute wealth in a "soak the rich" fashion is not going to ameliorate that. It would be nice to have a discussion about how public policy should be more than feel-good activism, but I suspect with the 2016 election cycle in swing, I doubt the majority of American people can transcend the knee-jerk, populist sentiments of sticking it to the rich.

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