A tax plan akin to a rising tide — lifting all economic boats
© Getty Images

The wait for President Trump’s tax plan is over, and the ensuing debate brings together several critical economic policy issues, including how to improve our lackluster growth rate and how to ensure that rising prosperity is shared among as many Americans as possible. The key question is: Can we improve both of these things?

The United States has long been the land of opportunity, but also one of persistent income inequality. Growth has slowed in recent years even while inequality increased. The latter development reflects the forces of technology and globalization rewarding the most highly-skilled workers while undermining the economic security of those with lower levels of education or skills. 

ADVERTISEMENT
The result is wider inequality which has left many Americans feeling that they have not shared in the gains from our economic recovery. Given that the rapid technological advances and globalization are here to stay, we must find a way to address inequality while boosting growth.

 

Political rhetoric during the 2016 campaign focused on soaring incomes among the rich, but research shows a more salient reason for wider inequality: The increasing value of a college education divides the “haves” from the “have-nots”, while earnings have been stagnant for those in the bottom half of the income distribution.

Historical reflection suggests that policies should focus on increasing incomes at the bottom rather than inequality per se. The late 1990s is often remembered as a good time in U.S. economic history because real incomes grew throughout the income distribution.

But inequality actually increased from 1995 to 2000, because the income gains at the top were much larger than those at the bottom or middle. What seems to matter most for society is that incomes rise for everyone — with prosperity broadly shared but not necessarily equally shared.

In new research published by the Mercatus Center at George Mason University, I discuss how even significant increases in the top tax rate would produce only modest declines in inequality. The income tax hikes needed to fund greater redistribution would likely be harmful to economic growth, as would other taxes motivated by redistribution, such as higher capital taxes and financial transaction taxes. 

Indeed, such measures might well backfire. Over time, wages broadly track productivity, but higher capital taxes reduce saving and investment, and thus lead to slower productivity growth — hurting rather than helping workers.

The implication is that tax reform should maintain considerable progressivity, but focus less on inequality and more on ending stagnant growth. 

Addressing the challenge of stagnant incomes among less-educated or poorer Americans requires a concerted policy effort at multiple horizons. In the near term, we should focus on getting more people into the workforce, increasing before-tax earnings and raising incomes with the least possible distortion to overall growth.

Improvements to the Earned Income Tax Credit (EITC) should be at the center of this agenda, because the EITC boosts workers’ take-home pay and strengthens the incentive for people to work in the first place.

Beyond taxes, supportive efforts such as childcare subsidies might also increase labor force participation and pre-tax earnings among lower-income workers, and improve intergenerational opportunity through better child outcomes. A long-term agenda would include a renewed focus on improving the education and skills of both youths and adults, and addressing social issues, such as the opioid crisis, that contribute to a culture of despair among too many families.

Tax reform should aim at growth, supported by a concerted policy effort aimed at realizing the human potential of all Americans. Doing so is not just a social imperative, but also an economic one, because the policies that advance incomes for those left behind by economic changes will likewise expand and improve the workforce, helping us to avoid the type of slow growth we’re experiencing today.

 

Phillip Swagel is a professor of international economic policy at the University of Maryland, and author of the new Mercatus Center at George Mason University study “Policies to Address Inequality and Increase Economic Opportunities for Low-Income Families.”


The views expressed by contributors are their own and not the views of The Hill.