This is from a guest speaker on economist.com's debate section
Audience participation
Comments from the floor.Featured guest
Professor Edward N. Wolff
In his presidential campaign, President Obama expressed considerable concern about rising income inequality in the United States, which is now at an 80-year high, and this was an important campaign theme. The president recently proposed to increase taxes on the rich. I support this measure.
The tax system as a whole has surprisingly little redistributional punch currently in the United States. Using a measure of "comprehensive income", which includes, besides the usual measure of money income, total capital gains on wealth, imputed rent on owner-occupied housing, non-cash government benefits and public consumption, we find that income taxes are now generally progressive. Federal income taxes paid as a proportion of income increases steadily from 2% at the tenth percentile (that is the family ranked tenth from the bottom out of 100) to 14% at the 90th percentile, but then falls off slightly at the very top to 13%, reflecting the favourable treatment of capital gains and investment income under the Bush income-tax laws.
Social security taxes are now the biggest tax paid by over two-thirds of families and are, on the other hand, mildly regressive. Social security taxes as a proportion of comprehensive income rises gradually from 5% at the tenth percentile to 9% at the 80th percentile, stays at 9% at the 90th percentile but then falls off sharply to 5% at the top. This decline reflects the wage cap on social security taxes (currently at $102,000).
We also include sales tax, which is steeply regressive, and property taxes, which are progressive, to obtain the total tax burden on families. Total personal taxes are mildly progressive. Total taxes as a share of comprehensive income increases steadily from 14% at the tenth percentile to 28% at the 90th percentile, but then falls off sharply to 22% at the top. This sharp drop at the end is due to three factors: first, the favourable treatment of capital gains and investment income; second, the wage cap on the social security earnings tax; and third, the sharp regressivity of sales taxes.
However, considering the role of fiscal policy on inequality it is not enough to consider only the tax side. You must also consider the expenditure side of government. Transfers, like social security and unemployment insurance, are, as is well known, quite equalising. But the full extent is not generally known, particularly when we include the value of non-cash government benefits like Medicaid, Medicare and food stamps. Total transfers are extremely progressive. In 2005, total governmental transfers (including non-cash government benefits) as a percentage of comprehensive income fell almost continuously, from 50% at the tenth percentile to 2.5% at the very top. Transfers in total have a much bigger equalising effect on family incomes than the tax system as a whole.
But government spending has distributional consequences too. Indeed, an equal punch comes from what we call public consumption. This consists of actual government expenditures on goods and services, like education, highways, police and sanitation. We allocate government expenditure to the actual beneficiaries of that spending, in much the same way as government transfers. Educational expenditures are allocated on the basis of the number of schoolchildren in the family. Highway spending is allocated in proportion to the number of cars owned by the family and estimated miles driven. Collective goods like fire and police protection are allocated on a per-head basis. The largest type of public consumption is primary and secondary school expenditures (45% of the total), followed by road and highway spending (at 9%).
Public consumption is just as progressive as government transfer payments. As a percentage of comprehensive income, it also declines almost continuously, from 34% at the tenth percentile to 3% at the very top. The main beneficiaries of public spending are the poor and the middle class.
When you add together government transfers and public consumption and subtract taxes paid, we come up with what we call net government expenditures. These are extremely progressive. As a share of comprehensive income, it declines sharply from 70% at the tenth percentile to -16% at the top (that means, the top bracket pays more in taxes than it receives in government benefits). In fact, the crossover point between positive and negative net government expenditures is at the 66th percentile. The extremely progressive nature of net government expenditures comes about equally from government transfers and public spending; very little is contributed by taxes.
By the way, it is not just the poor who benefit from net governmental expenditures. The middle class are also a big beneficiary. Between 1959 and 2005, we estimate that about half of the growth of the comprehensive income of the middle class came from increased net government expenditures. Indeed, from 2000 to 2004, the increase in net government expenditures accounted for 150% of the growth of comprehensive income, as other sources of income shrivelled up. Net government spending also helped to reduce overall inequality over those years.
So, taxing the rich has two important consequences for reducing inequality. First, it will make the overall tax system more progressive. This is important since as it now stands the US tax system is only mildly progressive and, indeed, regressive at the top. Second, taxing the rich will provide more money for government expenditures. Since government expenditures are highly progressive, additional government spending will further reduce overall inequality in the United States. Moreover, additional state spending will likely further expand the comprehensive income of the middle class and therefore make them better off.
Posts
