Tackling Income Inequality: Which Policies Will Make a Difference?

A key priority of the Biden administration is to lessen the disparity in income between the wealthiest U.S. households and the rest of the populace: The top 10% today account for one half of pre-tax national income.

Emmanuel Saez of U.C.-Berkeley contends income inequality is the greatest since the “Gilded Age” of the 1920s. It has resulted in strains between “The Haves” who are college educated and “The Have Nots” who are less educated and live in rural areas or inner cities. 

As America has become polarized, there is growing recognition that the latter groups no longer can be ignored. Still, many wonder what can be done to lessen the disparities in income and wealth.

What is clear is there are no easy fixes. American workers benefited from rapid economic growth during much of the post-war era, but labor’s share of national income began to decline at the turn of this century from 64% to 57% today. This compression is attributed to increased competition from China and other emerging economies, as well as to technological change that has mainly benefited the highly educated.

As the Biden administration sets out to alter this trend, it is targeting several areas. The most pressing need is to counter the deleterious effects the COVID-19 pandemic has had on those who lost their jobs or do not earn adequate income to live on.

The administration’s $1.9 trillion relief package includes support payments of $1,400 for qualifying households that are in addition to the $600 enacted in December. While polls show the transfer payments are popular with the electorate, several issues have surfaced that could result in modifications to the proposal.  

One push back from Republicans is that a considerable portion of the checks provided in the CARES Act was saved rather than spent: The personal saving rate rose to nearly 34% in April, and it is still relatively high at 13.6%. Accordingly, Republicans are pressing for payments to be targeted to the truly needy. Biden reportedly is willing to consider tightening the eligibility requirements but not the $1,400 amount. 

The proposed extension in unemployment benefits from March until September has also drawn criticism, because the benefits are higher than in the past. Matt Weidinger of AEI estimates that over half of recipients would collect more from them than from their paychecks. As a result, they lessen incentives for recipients to seek employment and could increase the number of long-term unemployed.
 
The bottom line is that increased transfer payments are an efficient way to get money to people, but they need to be targeted to the neediest and to lessen disincentives for them to work.

Another way the Biden administration is seeking to lessen income inequality is by taxing the wealthiest Americans. The administration is holding off doing so until the worst of the pandemic is over. However, tax changes are expected to be enacted later this year and could become effective in 2022.

The plan that Biden unveiled during the election campaign called for the marginal tax rate on individual income above $400,000 to be raised from 37% to 39.6%. It would also tax capital gains for millionaires at the ordinary rate and reduce the stepped-up basis for estate taxes that was in the Trump tax cuts. Altogether, the top 1 percent of households would shoulder 80% of the tax increase.

If enacted, these changes are estimated to increase federal revenues by about $400 billion over ten years. However, they are not likely to alter income inequality materially.

To put this in perspective, a study by the Brookings Institution examined how much income inequality would be reduced if the top individual tax rate were raised to 50% and the proceeds accrued to the bottom quintile of income distribution. The report concludes that “the resulting effects on overall income inequality are exceedingly modest.” 

The key finding is that to alter income distribution materially many more Americans would have to pay higher taxes. However, this is a non-starter politically.

Finally, the principal way the Biden administration is seeking to address income inequality over the long term is via public investments in education and infrastructure and R&D. The goal is to transform the American economy to make it more knowledge-based and less reliant on fossil fuels.

If enacted, the increased public investment would be the most ambitious program since the launch of the “Great Society.”

Based on analysis of the Penn Wharton Budget Model, the planned spending on education would cost $1.9 trillion over ten years.  It would include provisions for universal pre-K, increased funding for Title 1 schools, two years of debt free college and free public college for students from low-income families.

Spending on public infrastructure and R&D is estimated to cost $1.5 trillion over the same period.  It would include improved public transit, green infrastructure projects and “breakthrough technology” such as 5G and artificial intelligence.

At this juncture, it is too early to tell how much traction the proposal will get.   Republicans are sure to fight it on grounds that it is too costly and the results are uncertain. Some Democrats may also have reservations considering the federal budget deficit is at a post-war high.

Still, the proposal deserves to be debated in the public arena. While politicians typically focus on issues that affect the outcomes of elections, the policies that will have the greatest influence on the economy’s long-term potential take years to play out. In my view, improving the quality of education so American workers can compete in a global market place that is subject to rapid technological change should be a top priority.