Entitlement, Not Tax Cuts, Widen the Wealth Gap
Michael Barone - www.townhall.com
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What should be done about income
inequality? That basic question underlies the arguments hashed out in the
supercommittee and promises to be a central issue in the presidential campaign.
Supercommittee
Democrats argue that income inequality has been increasing and can be at least
partially reversed by higher tax rates on high earners. They refused to agree
on any deal that didn't include such tax increases.
Supercommittee
Republicans offered a plan to eliminate tax preferences and reduce tax rates,
as in the 1986 bipartisan tax reform. They argued that high tax rates would
squelch economic growth.
They didn't make
the case that their proposals would also address income inequality. But House
Budget Committee Chairman Paul Ryan, in a 17-page paper based largely on a
Congressional Budget Office analysis of income trends between 1979 and 2007,
has done so.
Ryan, a Republican
from Wisconsin,
makes the point that the government redistributes income not only through taxes
but also through transfer payments, including Social Security, Medicare, food
stamps and unemployment benefits. The CBO study helpfully measures income,
adjusted for inflation, after taxes and after such transfer payments.
Many may find the
results of the CBO study surprising. It turns out, Ryan reports, that federal
income taxes (including the refundable Earned Income Tax Credit) actually
decreased income inequality slightly between 1979 and 2007, while the federal
payroll taxes that supposedly fund Social Security and Medicare slightly
increased income inequality. That's despite the fact that income tax rates are
lower than in 1979 and payroll taxes higher.
Perhaps even more
surprising, federal transfer payments have done much more to increase income
inequality than federal taxes. That's because, in Ryan's words, "the
distribution of government transfers has moved away from households in the
lower part of the income scale. For instance, in 1979, households in the lowest
income quintile received 54 percent of all transfer payments. In 2007, those
households received just 36 percent of transfers."
In effect, Social
Security and Medicare have been transferring money from low-earning young
people (who don't pay income but are hit by the payroll tax) to increasingly
affluent old people.
The Democrats,
perhaps following the polls and focus groups, have been protecting these
entitlement programs that have done more to increase income inequality than the
Reagan and Bush tax cuts put together.
Ryan makes three
more points that may strike many as counterintuitive.
First, reductions
in some transfer payments haven't hurt the living standards of most
low-earners. The prime example is the welfare reform act of 1996, which reduced
transfers to single mothers but induced many of them to find jobs that left
them better off economically and, probably, psychologically.
Second, Americans
aren't trapped in one segment of the income distribution. A Tax Journal
analysis of individual income tax returns found that 58 percent of those in the
lowest income quintile in 1996 had moved to a higher income segment by 2005.
This comports with common experience. We move up and down the income scale in
the course of a lifetime.
Finally, the
inflation adjustment used in the CBO analysis was the Consumer Price Index. But
that tends to overstate inflation (as any indexes tends to do, since it
measures the cost of a static market basket of goods and services). A study by Chicago economist
Christian Broda found that prices for goods purchased by low-earners have been
rapidly decreasing, while prices for goods of high-earners have increased.
Kids' school clothes may be cheaper at Walmart than they were years ago, while
prices at Neiman Marcus keep increasing.
So if the question
is how to compensate for increasing income inequality, higher tax rates on
high-earners won't do much -- and could be counterproductive if they diminish
economic growth.
A better way is
suggested by the supercommittee Republicans: Limit future increases in transfer
payments to affluent households, and cap deductions for home mortgage interest
and state and local taxes, which are hugely lucrative for high-earners and
worthless for low-earners who don't pay income tax.
These proposals
won't reduce income inequality altogether. Much of the increased inequality
comes from the huge increases for those in the top 1 percent of earners. But we
wouldn't be better off if Steve Jobs had never existed.
Keeping
entitlements as they are and raising tax rates on high-earners is a recipe for
Europe-style stagnation. Ryan and the supercommittee Republicans point toward a
better way.
Michael Barone,
senior political analyst for The Washington Examiner
(www.washingtonexaminer.com), is a resident fellow at the American Enterprise
Institute, a Fox News Channel contributor and a co-author of The Almanac of
American Politics. To find out more about Michael Barone, and read features by
other Creators Syndicate writers and cartoonists, visit the Creators Syndicate
Web page at www.creators.com.
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