FAIR SHARE

Economists aren’t usually political—rising inequality is changing that

If one person makes $500,000 a year and another makes $50,000, how much should each pay in taxes?

It is one of the great questions of public policy, and one that economists typically deflect. Historically, economists answer that it is not for them to say—economics is only concerned with efficiency, and redistribution is a moral question. But rapidly rising inequality in countries across the world has prompted some economists to weigh in.

In a recently released paper (pdf) “Should the Rich Be Taxed More: The Fiscal Inequality Coefficient,” the economists John Hatgioannides of City University in London, and Marika Karanassou and Hector Sala of the independent Institute for Labor Economics, argue that it is high time to put managing inequality on an equal footing with goals like increasing GDP, managing inflation, and restraining unemployment. Their position is based on the belief that rising inequality is a threat to liberty and capitalism because it leads to too much power in the hands of a small number of people. “We feel that inequality is the missing vital fourth statistic of economic well functioning,” they write.

The researchers see redistributive taxation as an important tool for combating inequality. Specifically, significantly increasing taxes on the rich. They point out that as the rich receive more of the pie, the share of the taxes they pay has not risen commensurately. The analysis is focused on the US, but they believe the findings would translate to other advanced economies.

Their argument is based on the idea that the share of income tax rate a group pays should be related to the share of all income they make. So since the share of income going to the top 10% of earners rose from 36% in 1960 to 47% in 2014, they believe the tax rate of those groups should go up as well.

In reality, the effective tax rate on the top 10% of earner’s incomes from 1960 to 2014 stayed around 33%. During this period, the top marginal income tax rate fell from 91% to 39.6%, but a number of deductions were eliminated, which ended up cancelling each other out. At the same time, income tax rates on the bottom 90% of earners rose from 23.9% to to 27.6%.

As a result, the ratio of taxes paid by the top 10% of earners in comparison to their share of all income fell from 1.22 in 1960 (44% of all income taxes divided by 36% of all income) to 1.11 in 2014 (52% of all income taxes divided by 47% of all income). In order to keep the 1.22 ratio, the top 10%’s effective income tax rate would have to be raised to about 40%.

These researchers join economists like Thomas Piketty, author of the 2013 bestselling inequality opus Capital in the Twenty-First Century, in calling for higher taxes on the rich to restrain the economic and political power of the wealthy.

Not everyone thinks this is the best solution.

Economists at the Brookings Institution estimate that increasing income tax rates (pdf) on the rich to 50% and redistributing that money to the poor would only have a small effect on inequality in the US. They argue that improving educational outcomes for the poor would do much more to increase their relative welfare. This argument points to the idea that raising taxes on the rich, and pouring that money into education, might be the best way to combat inequality.

While economists debate how much income tax increases would decrease inequality, current Republican tax reform proposals would actually cut the income tax rate on the wealthy, and taxes overall. Most Republicans believe that cutting taxes on the wealthy will stimulate the economy and lead to more and better jobs for middle-class workers. But research has shown this to be wishful thinking. Non-partisan analysis of current Republican tax proposals suggest they will increase inequality, while having little effect on long term economic growth.

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