Bryan Caplan  

Does the U.S. Government Increase or Decrease Income Inequality?

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The view that the U.S. government actually increases income inequality used to be limited to (some) libertarians and socialists.  After the bailouts of 2008 and beyond, though, even moderates might start to wonder. 

Where does the truth lie?  Please show your work.


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COMMENTS (23 to date)
David Friedman writes:

I don't think it's practical to give a solid empirical answer to the question, but the pattern of poverty rates is at least suggestive. From WWII to the start of the War on Poverty, they were declining pretty steeply. From the point when the War on Poverty got really going--programs fully funded--it's been roughly constant, going up and down with economic conditions.

Peter H writes:

Main arguments that Gov't decreases inequality: progressive taxation and cash/in kind benefits to the poor.

I would argue that the current tax and benefit system (disregarding the bailouts entirely) increases nominal inequality, that is, increases inequality of baseline income, by strongly disincentiveizing people from gaining hihger paying work, due to astronomical implicit marginal tax rates in the $20,000 to $50,000 range.

Let's begin with non-implicit marginal tax rates. At 20,000 (about $10 an hr full time), a single person will be in the 15% bracket, which means a marginal federal rate of 30.3% (15% income, 15.3% FICA) assuming standard deduction. Add on state taxes for my home state and you get a 36.2% marginal tax rate. Let's assume a householder with some kids though, and although the nominal tax rate will drop to 31.2% (down to the 10% bracket), the implicit rate will be much higher. NY for example has a medicaid cutoff at about $12,000 for a family of 3, but provides a 50% subsidy to health insurance thereafter. The cheapest 50% off parent+children plan is $525/month (NY has guaranteed issue and community rating, so our rates are extremely high). The 50% subsidy lasts until an income of about $45k for a family of 3. So over the period $10,000 to $15,000, the implicit marginal tax rate is well over 100%, since you lose medicaid, and instead would have to pay $6300 to replace it with subsidized coverage, plus pay taxes on the new income.

Then there's the EITC, SNAP, TANF, and a host of other things that make for very high implicit marginal tax rates in the lower-income areas. People respond to these incentives, and will often seek off the books work or else not work, since they will lose more than they gain.

The government has not taken a wholistic approach to the social safety net, and has therefore created a system that punishes people who try to move up by stripping them of benefits at a faster rate than their incomes rise.

Anthony writes:

Increases. Without government we'd have bellum omnium contra omnes.

Les Cargill writes:

Increases. Government adapts to technology badly, which has "halo" effects leading to poor and poorer cost reduction ability in peripheral industries.

It also tends to follow V-22 Osprey "camel" tech projects which prevent real innovation and cost reduction.

Technological rent-seeking in government drives out real innovation, which is approaching an all-time low. The emphasis on the interactions between the Fed and Wall Street totally mask this in the public sphere - but there are big buildings full of obsolete and failing technology in the government space, and as the Virginia IT thing shows, attempts to improve cost by application of technology fail more often than not. In government, failure doesn't lead to innovation, it tosses a cow into the village well...

And ditto David Friedman's post. :)

Ironman writes:

Do you mean directly by what it compensates (earnings + benefits) the people who work for the U.S. government, or by acting to promote the interests of the largest campaign contributors to those elected to government office?

Either way, the answer is: yes, the U.S. government increases income inequality.

(The source referenced in the second link above appears to only be available in
cached form.)

Gary Rogers writes:

I am not sure it is big government per se than what big government does. First, I would blame regulation which increases the threshold for starting new mom and pop business and generates record keeping and compliance jobs at the expense of creative positions which lead to greater long range advancement. Second, targeted inflation coupled with artificially low interest rates channels investment to large financial institutions at the expense of the individual savers. Banks grow by borrowing cheap from the Fed and lending money at higher rates. Is it any wonder that individual savings are disappearing and that individuals can no longer get ahead by saving a little bit out of their paycheck each week?

To reduce the economic divide is as simple as making more opportunities to climb the economic ladder. Opportunities grow out of creative ideas. Governments are much more likely to cut off economic paths than to add them, mostly because the ideas have not yet been conceived when the government makes some regulation that keeps someone from pursuing an opportunity in the future.

I rambled a bit, but I think there might be an idea in this.

Blackadder writes:

Decreases. OCED countries where government is bigger tend to be more equal. I believe the same is true (though with more noise) for comparisons between the states.

Doc Merlin writes:

Wealthy benefit most from tax policy.

http://finance.yahoo.com/news/Wealthy-benefit-most-from-tax-rb-6327795.html?x=0&sec=topStories&pos=3&asset=&ccode

Jeff Oxman writes:

Big government can decrease income inequality - by making everyone poor. Witness Europe.

Sonic Charmer writes:

The main things the government does to affect income are regulation/taxation (which create barriers to entry, both for businesses and for employees), and welfare of various kinds (which create dependence and reduce incentives for intiative). Both serve to increase income inequality.

The biggest effect is probably just the concentrative power of the government, in a society that gets bigger and wealthier but remains overseen from one swampy city by 435 congressmen, 100 senators, one "President", etc. and all their hangers-on. The government-teat and similar effects create rent-seeking income opportunities for the well-connected elites, and this factor alone would increase inequality even if all else were equal (i.e. the government weren't busy creating barriers to entry and perpetual dependence in the process). Which it isn't.

In short: the answer is, increase.

Peter Gordon writes:

What do we know? Inequality (using standard measures) has increased as the role of the state has grown.

Troy Camplin writes:

The question is U.S. government, not generic government involvement (which can erase differences by making everyone poorer).

The U.S. government creates increased wealth disparity through subsidies. The subsidies typically go to larger corporations, but come from individuals and small businesses. More than that, various protectionist laws, barriers to entry, etc. also benefit the already-rich at the expense of those who want to enter into the market. Government regulations create oligopic markets -- one can think of the Big Three auto makers. One would expect exactly such a situation in a pro-business, anti-market political economy.

Ron Davis writes:

As our government (not just Federal) has grown, so has society's willingness to adopt a "serf mentality." Serf's believe that wealth is ill gotten and stolen from the sweat of their work and class envy runs wild. In their view, the size of the pie is fixed and "fairness" means it must be split evenly and redistributed so everyone can have a piece.

Today, the economy is in a funk and trillions sit on the sidelines waiting to be employed. This will never happen as long as big government policies and pronouncements aim to punish this money. A government that is engaged in redistribution of wealth to unproductive government employees, threaten to raise taxes on wealth and increase regulation on that wealth seem surprised when the people controlling that wealth choose to sit on the sidelines and earn 1% in money markets instead of risking it to expand business or start new ones. Governments expect the wealthy (Earners of over $250,000 by their definition) to continue to do what they have always done - risk capital so jobs might be created so the government can increase regulation and confiscate the returns on that wealth. Owners and producers of wealth are more prone to not risk that capital in the first place when they see that scenario developing.

Over 51% of American households have some form of government assistance arrive at their mail box monthly. In many cases it is social security, but, but still the result of redistribution. Over 50% of Americans owe their paychecks to some level of government. The rest of us are required to produce the wealth that produces the taxes to employ those on the dole as well as the city, county and federal workers who have incomes and guaranteed retirements way in excess of the average private sector employee.

This war on wealth has been a long time coming and is a direct cause of changing attitudes that has come to the point where it is now OK to go down the street and knock on a door at random and ask that complete stranger to pay for your healthcare because it is the fair thing to do and besides, you can afford it. We as producers will simple hide our money and stop exposing ourselves to public ridicule and shut off the engin of job creation.

Therefore, yes, government is the cause of poverty and disparity in wealth.

Dewey Munson writes:

As the late Adrian Rogers said, "you cannot multiply wealth by dividing it."


An economics professor at a local college made a statement that he had never failed a single student before, but had once failed an entire class. That class had insisted that Obama's socialism worked and that no one would be poor and no one would be rich, a great equalizer.

The professor then said, "OK, we will have an experiment in this class on Obama's plan. All grades would be averaged and everyone would receive the same grade so no one would fail and no one would receive an A..."

After the first test, the grades were averaged and everyone got a B. The students who studied hard were upset and the students who studied little were happy. As the second test rolled around, the students who studied little had studied even less and the ones who studied hard decided they wanted a free ride too so they studied little.

The second test average was a D! No one was happy.

When the 3rd test rolled around, the average was an F.

As the tests proceeded, the scores never increased as bickering, blame and name-calling all resulted in hard feelings and no one would study for the benefit of anyone else.

All failed, to their great surprise, and the professor told them that socialism would also ultimately fail because when the reward is great, the effort to succeed is great, but when government takes all the reward away, no one will try or want to succeed.

Could not be any simpler than that.

Bob Knaus writes:

That's a great story, Dewey. Too bad it falls into the "legend" category at snopes.com. According to them, it's been around since at least 1994.

Hyena writes:

I think the following policies tend to increase inequality:

  • Standardization of practices. Standards will tend to exaggerate winner-take-all effects in society by increasing the size of a firm's customer base or decreasing the dimensions along which firms can compete.

  • Persistent deficit spending. Because much debt is purchased by countries who maintain currency pegs, deficit spending will tend to increase the returns on imports and improve the margins of geographically fluid capital over relatively stationary labor.
  • Corporate taxation. Because current tax practice rewards firm growth more than profitability, it encourages firms to become larger, with greater revenue though not always profitability. At the margins, it should reduce the availability of many management positions and increase the pay of the remainder.
  • Taxes as applied to real estate. Current tax practice allows a number of deductions which tend to benefit real estate investment. Because much of the value of real estate is in the appreciation of land values, this preference increases the returns to investment relative to labor. Because real estate tends to be expensive and initial outlays large, there is a natural barrier to entry for a tax-preferred entrepreneurial strategy.
  • General business taxation. Some forms of business allow people to engage in consumption under the guise of business. While not strictly legal, it is apparently easy to do. At the margin, this increases the returns to business owners in a way which is not easily extended to employees.
Dewey Munson writes:

Bob Knaus - is a legend fact or fancy?
Are our math constructs facts or legend?

Bob Knaus writes:

Dewey - if you Google stuff before you post it, you will save yourself a lot of trouble. That's all I have to say.

Floccina writes:

How could one know? I think that things like patents, copyright, licensing increase inequality. On the other hand things like progressive taxation and some welfare programs would seem to decrease inequality.

Too complicated to figure out but I have worked a lot in Fargo ND where most of the people are from Scandinavian decent and if you compare the people there to the Scandinavians in the Scandinavian countries, it appears for all the great effort of the Scandinavian gov over those in ND they seemed to only have narrowed the gap by lowering the top earners wealth. In other words very little change per added unit of effort above our base line.

Prakash writes:

The truth lies closer to increasing inequality.

From a Georgist perspective, the taxation system that taxes labour income instead of land is definitely a huge factor that increases inequality. The tax subsidy for purchasing homes makes things even more worse.

If we see from a banker's perspective, then easier loans from the fed to already large banks is a factor that increases inequality.

So, land and money, two things needed to start a business are made inordinately expensive.

The war against drugs, imprisoning many people and reducing their options increases inequality.

On the side of reducing inequality, there are income transfers, but instead of being a simple basic income to all or a negative income tax, it provides disincentives at a particular income level like Peter H has mentioned.

RPLong writes:

Increases inequality by reducing class mobility.

Guy in the Veal Calf Office writes:

Increases inequality, because it rigs methods of measuring inequality to inflame opinion in favor of more government action.

Seriously, what is a good measure of inequality? Gini? collection of consumer items? relative access to food, shelter, clothing & longevity?
I like comparing an income cohort to its generational predecessor or its analog in other countries, because that gets me the answer I like.

Kevin writes:

Increases. Not even close. By enforcing relatively strict, liberal property rights, the government allows nature to take its course - tournament-style payouts for the few winners and bankruptcy for millions of losers. Does anyone believe Warren Buffett, Steve Jobs, etc. would have even a thousandth of their wealth without state-enforced property rights?

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