Reducing inequality: how to pay for it

by lane on April 18, 2009

The Labour Party returned to power in the U.K. in 1997 based in part on a pledge by Tony Blair and Gordon Brown not to raise taxes’ share of the British economy. In his 2008 presidential campaign, Barack Obama promised to reduce taxes for the bottom 95% of Americans. In both instances this commitment succeeded in insulating the progressive candidate from what had become the right’s most powerful electoral club: stoking fear of tax increases by the left.

But while it may be smart electoral politics, committing not to increase taxes’ share of GDP, as Blair did, or to lower taxes for most of the population, as Obama has done, makes it difficult for a government to make much headway in addressing income inequality. Obama has some leeway; the economic crisis has necessitated increases in government spending that can justifiably excuse some backtracking on his campaign pledge. Fully consistent with his promise, he should increase the tax rate on high-end incomes (beyond simply letting the Bush reductions expire). Two other progressive tax reforms are worth pursuing, though they would affect some in the bottom 95%. One is to reduce or end the homeownership subsidy. More than 80% of the $160 billion in foregone revenues from the deduction for mortgage interest and property tax payments goes to households in the top income quintile. The other is to introduce a modest tax on financial transactions.

But should the focus be confined to steps that make the tax system more progressive? Many on the left view heightened progressivity as the key to inequality reduction. Yet in the United States and other rich countries the tax system overall, including taxes of all types and at all levels of government, is essentially flat; households throughout the income distribution pay roughly similar shares of their market income in taxes. As the following chart shows, inequality reduction is achieved not through taxation but with government transfers (and services).

Taxes help to reduce inequality mainly via their quantity rather than their progressivity. The greater the tax revenues, the more government is able to boost incomes and living standards of those in the lower half of the distribution with transfers and services.

Moderate or high levels of tax revenue can’t come solely from higher rates or new taxes on the rich; the math simply doesn’t work. To significantly increase spending on transfers and/or services, President Obama and/or his successors will need to increase taxes on the middle class. One way to do this would be via a federal consumption tax, such as a value-added tax (VAT). We have state and local consumption (sales) taxes, but we raise less money from consumption taxes than any other rich country. Consumption taxes are regressive, and for that reason they’re often dismissed by the American left. But they can be tweaked to limit the degree of regressivity. And if the money is put to progressive use, the benefits may outweigh this drawback.



StevenAttewell 04.18.09 at 6:13 am

I’m not so sure about this.

1. What is the functional difference between refundable tax credits and government transfer programs? Are greater progressiveness of the tax code and increased transfer programs actually two different policies or the same policy?

2. I think there should be a division here between what is and what can be. It is the case that “inequality reduction is achieved not through taxation but with government transfers,” but that’s a descriptive statement, not an axiomatic statement. Governments could choose one strategy, they just happen to choose another.

3. If we want to increase taxes on the middle class, why do so through a VAT? That seems like the bluntest possible instrument to accomplish the targeted objective. Why not just increase the marginal tax rates on the middle income brackets instead?


Adam Herman 04.18.09 at 6:56 am

But now we’re not making sense. If you raise taxes on the middle class, just to give a portion of it back to them, that’s doing nothing for inequality. Taxes on the middle class make sense for:

1) building of infrastructure, funding defense, basic government services
2) Taking middle class money now to give it back down the road on the assumption middle class taxpayers won’t save it. Ie, Social Security and Medicare
3) To fund social programs to help the poor

But the last few posts haven’t been about any of that, they’ve been about mitigating income inequality, an issue which affects the middle class. But if you tax the middle class more, you defeat the whole purpose. It makes no sense to tax me an extra $1000 and then give me a $1000 EITC. It doesn’t even make sense to tax me an extra $1000 to give me a $5000 EITC. Why not just not tax me more at all and give me a $4000 ETIC?


Henri Vieuxtemps 04.18.09 at 9:01 am

Steven, I get the impression that VAT (at least in Europe) is simply a slightly disguised method of protectionism, because the exports are exempt from VAT. So, importing something to France adds 20% to the price, and exporting something from France to (for example) the US makes it 20% cheaper, easier to sell.


gordon 04.18.09 at 12:45 pm

Even if Prof. Kenworthy is right and the effective household rates over all forms of tax are effectively flat, is that an argument for introducing a regressive VAT?

I note in passing that individual effective rates for all taxes in the US aren’t flat across income quintiles (ack. Economist’s View), and household rates for Federal taxes alone aren’t flat(.pdf) (ack. CBPP) either. That doesn’t prove that Prof. Kenworthy is wrong, but maybe he could give us a reference.


StevenAttewell 04.18.09 at 5:33 pm

Wouldn’t surprise me, Henri.

It’s funny, though – if I were living in France (or any other European country, but France makes a good example), and getting involved in politics, one of the major things I’d try to get reformed is the fiscal overemphasis on the VAT and payroll taxes. While I don’t agree with everything he writes, Timothy Smith’s book France in Crisis (, does usefully point out that payroll taxes in France add a huge cost onto the creation of new jobs, and we all know the impact of VAT taxes.

The size of tax collected aside, I personally prefer the American (Federal) system which puts more of an emphasis onto taxing income and wealth, over a system that emphasizes taxing payrolls.


Henri Vieuxtemps 04.18.09 at 8:17 pm

Actually, except for RE property tax, the US system doesn’t tax wealth, only the income. The French do.

For example: suppose someone’s net worth (total assets) is $100 billion and he had no income last year (or perhaps even lost money). In the US he could conceivably pay $0 tax. In France he would pay $1.8 billion.


terence 04.19.09 at 12:18 am

hhhhmmm…as sort of mentioned above:

Isn’t the reason for the economies listed having systems of taxation that are ultimately flat, the fact that they combine progressive income taxation with regressive indirect taxes (VATs etc)?

And if this is the case then surely raising indirect taxes is hardly going to help with reduce inequality?


Robert Waldmann 04.19.09 at 10:02 am

I totally disagree with the analysis in the post above. The important issues are first what is optimal policy and second what are political limits on policy. I think on both issues Obama is right and Lane is wrong.

First, the argument against Obama is that tax progressivity does not determine the effect of the fiscal system on inequality. It is not that, other things equal, a more progressive tax system is worse. Some have made that argument, basing their claim on the incentive effects of high marginal tax rates. However, the post does not make the argument. Rather from the claim that something is not “the key” follows the claim that it should not be an aim. This is the oldest rhetorical trick in the book.

Second, and more importantly, raising taxes on the rich is much easier politically than raising the taxes on the non rich. This isn’t just electoral politics. Discussing optimal policy is a parlor game unless one asks how it will be enacted. There is no evidence at all to support the claim that the incorrect beleif among progressives that progressivity is “the key” to reducing inequality will cause reduced total tax revenues. There isn’t even an argument.

The evidence presented is, I think, based on the assumption that Europe is perfect. If European taxes aren’t very progressive, then taxes shouldn’t be very progressive. Otherwise what is the point of noting that European taxes aren’t very progressive. It sure doesn’t show that taxes can’t be progressive.

Importantly, different countries are, uhm different. The USA has an extremely unequal distribution of pre-tax income. Other things equal, that would mean that the US can raise an extremely high share of GNP as taxes by taxing the rich. In the USA a small fraction of workers are self employed. This makes it easier to collect income taxes. Many people receive huge compensation from large firms which keep track of everything. They can be taxed. The USA isn’t Europe. Even if it were true that European policy is optimal for Europe, it would not necessarily be optimal for the USA.

The key policy relevant assertion in the post is “Moderate or high levels of tax revenue can’t come solely from higher rates or new taxes on the rich; the math simply doesn’t work.” What math ? Where is that math ? It certainly isn’t in the post.

There is now a fairly large blogoliterature all making the same argument based on the same few data points. If someone has addressed the question of what the math says about whether moderal or high levels of tax revenue can come solely from higher rates or new taxes on the rich in the USA, I would like a citation.

Evidence from Europe or the USA during the period of a much more equal income distribution does not count. The share of income going to the rich has an effect on the amount of revenue which cain be raised by taxing the rich.


Neil B ♪ 04.20.09 at 12:55 am

I think there are fallacies in standard right-wing style arguments to the effect that raising rates on the wealthy won’t bring in much revenue:
1. The amount by which the income of the top quintile etc. exceeds the average keeps going up, so each percentage point increase in top rates must (non-dynamically of course) bring in lots of revenue.
2. The RW-ers like to complain that the lower half or so don’t pay “any taxes” (forgetting FICA of course) so raising the rates whatever on “the rich” should bring in almost all of the proportional increase in revenue.

That aside, the basic reason IMHO income is more distributed in Europe is not taxation. It’s that their systems make it harder for speculators and CEOs etc. to skim off so much money to begin with (which is what matters most, not the *re*-distribution angle.) Am I right?


alec 04.20.09 at 2:51 pm


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