What’s the Best Way to Overcome Rising Economic Inequality?

What’s the Best Way to Overcome Rising Economic Inequality?

A debate over the use of progressive taxation and redistribution as a means of solving the problem of rising inequality erupted in the last week or so. The debate began with three publications, one from Edward Kleinbard, one from Nezih Guner, Martin Lopez-Daneri, and Gustavo Ventura, and one from Cathie Jo Martin and Alexander Hertel-Fernandez.  

They argue in turn that “progressive fiscal outcomes do not require particularly progressive tax systems,” “making taxes more progressive taxes won’t raise much revenue,” and “The way a tax system fights inequality isn't just redistribution. It's by generating enough revenue to fund programs and benefits that help middle class, working class, and poor people participate and succeed in the economy. While talk of taxing top earners may make for good political rhetoric on the left, relying on such taxes cannot pay the bills.”

Related: How Income Inequality Can Hurt the Economy

This brought responses from Jared Bernstein, Matt Bruenig, and Mike Konczal the three of whom, as Steve Waldman says in a nice summary of this debate, “offer responses that examine what ‘progressivity’ really means and offer support for taxing the rich more heavily than the poor.”

This debate brings up an important question: what is the best way to fight economic inequality? I think most people would agree that the best approach is to provide good jobs to working class households, and to make sure workers receive their fair share of the value of the output they produce. To this end, many people point to education as the solution to a “skills gap” among U.S. workers, and as a means of encouraging new businesses that need highly educated workers to locate in the U.S.

But this focus on the supply of competent workers is misplaced – there is little evidence of a skills gap. To the extent that there is a skills gap, it is easily overcome through on the job training. Nobel Prize winning economist Peter Diamond says it well

“The tighter the labor market and the more valuable the filling of a vacancy, the more a firm is willing to hire a worker who is a less good match, who may need more training.... The idea that the US economy is not adaptable and capable of dealing with the need for skills and jobs to adapt to each other is peculiar... When the labor market is tight and firms have trouble finding workers, they reach out to places they have not looked before and extend training in order to find workers who can fill their needs.”

Related: Income Inequality Greatest in Democratic States 

Thus, it is not the supply of well-trained workers that is the main problem, and simply calling for better education – something we’ve been trying to accomplish for decades in any case – is not the solution. Education ought to be available to all, and we need to do a much better job of making high quality education accessible to everyone. 

We can do much better than we are doing now. But it’s the demand for well-trained workers that is the main problem, not the supply. If the demand for these workers materializes, then, to turn Says law on its head, “demand will create its own supply.” For this reason, I am not at all opposed to supply-side policies that attempt to attract businesses that provide decent jobs to working class households--that’s exactly what we need.

What I am opposed to is the use of income tax cuts for the wealthy – what are known as trickle down policies – to accomplish this goal. There’s little evidence that these policies do anything to enhance economic growth, or to encourage the creation of decent, high-paying jobs. Instead, we need to focus on things such as investment in basic research at universities, tax cuts for research and development at businesses, and so on. Measures that encourage innovative start-ups could also be useful, but it’s basic research rather than start-ups that begin in someone’s garage that are the key to attracting the types of new and innovative activity that produce well-paying, inequality reducing jobs. 

Even with the best possible incentives, this will take time. What should we do in the meantime? One answer is to do nothing, but that is a dangerous approach given the political turmoil that can arise once inequality passes a critical threshold. In addition, recent evidence suggests that inequality of the magnitude we are currently experiencing is bad for economic growth. And if workers have not received the income they deserve – their contribution to the value of the output they produce – as has been the case for the last several decades, then progressive taxation and redistribution returns income to its “rightful” owners. It’s the fair and right thing to do. 

Related: Brookings Study Downplays Income Inequality 

So my approach to fighting inequality in the short-run is to use taxation and corrective redistribution to ensure that workers receive the income they deserve, to fix the distributional problems that have allowed those at the top to capture more than their fair share of income, and enact supply-side incentives that have been shown to work as soon as possible.

The hope is that the supply-side policies and corrections to the distribution of income will produce the types of jobs and equitable compensation that are needed to solve the inequality problem in the longer run. But there’s a chance that no matter what we do, the inequality problem will persist. If so, then progressive taxation and redistribution beyond what’s needed to ensure workers receive the value of what they produce may be the only answer. 

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