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Income redistribution tradeoffs and how they impact you

By William Beranek Analysis of efforts to redistribute wealth and income through tax and regulatory policies reveal a surprising insight regarding current policies. It reinforces the belief that reducing current tax rates would provide strong incentives for more individual work, more risk-taking investments and, hence, enhanced employment. ALL ARE AWARE OF the dictum that nature is unfair. Moreover, all recognize that talents, skills, IQs and genes are unevenly distributed. Yet no one has seriously proposed a breakthrough, human-genome study, which might lead to a more equitable distribution of talent. For the time being, however, society is constrained to take as given the existing distribution of skills. If so, we recognize that individuals with unique capacities to satisfy human wants are scarce. To provide them with incentives to share the fruits of their efforts, we allow them to charge whatever others are willing to pay. This is the exchange system. In such a regime, uneven distribution of income and wealth is inevitable. Further, degree of skill and accumulated wealth become highly correlated with the age of the income recipient. It is not surprising, therefore, that through hard work and sacrifice of personal consumption to accumulate wealth — and a touch of luck — income distribution, at any point in time, highly favors mature, older recipients. However, when society through taxation and government regulation attempts to redistribute incomes to achieve a fairer distribution, inevitably incentives among the taxed — especially the more heavily taxed — are impaired. Income redistribution usually is implemented through a progressive, discriminatory income tax structure. Such discriminatory rates further expand the disincentive responses to the taxes, as businesses and unions take measures to avoid paying them. Numerous special deductions, exemptions and tax credits are enacted, while unions negotiate for more employee perks, such as health insurance, as a substitute for wage increases, thus creating distortions in normal economic relationships and inefficiencies in the productive process. As a result, national income becomes lower, which decreases that all-important metric, per-capita income. However, these effects obscure an undercurrent of real angst. The negative incentive effect reduces the supply of valued goods and services provided by these gifted people, thus denying other members of society the opportunity to even trade for them. Such talented people strive to benefit themselves through serving the wants of others. CONSIDERABLE ANECDOTAL evidence, nonetheless, supports the view that the redistributive effort has a depressing incentive effect on taxpayers. At the same time, there exists little if any evidence demonstrating a positive productive effect on low-income beneficiaries, who often view these distributions as a “right,” or entitlement. Fairness sought in this manner is justified as an act of welfare, not an enhancement of economic efficiency. Further, the entitlement relationship, which is between an impersonal government and a citizen, does not substitute for the bond that can emerge between a charitable distributor and a beneficiary. The former is a right, while the latter relationships can elicit gratitude from the recipient — an entirely different emotion. This brings us to the heart (no pun intended) of the fairness problem. Overall, this conflict between ingrained features of human nature and society’s concept of fairness lies at the center of the fairness dilemma. Alternatively, some economists view this collision as one of “efficiency” vs. “fairness,” or “equity.” However, a more precise statement is one of “freedom to choose” or “freedom to contract” vs. “equity.” At least understanding the basis of this conflict allows us to think more clearly about the issue. Despite acknowledging this trade-off, it is widely agreed among most economists that income redistribution reduces work and risk-taking incentives. If so, then with income redistribution we may obtain increased equity in the income-distribution sense, but at the cost of a decline in overall income levels. Society’s tough decision becomes: (1) a redistribution policy with declines in incomes; or (2) a policy without redistribution but with income growth a very likely outcome. THIS LEADS TO the final important conclusion. If current tax rates tend to reduce incentives for work and risk-taking investments, then a reversal of the process — i.e., lower tax rates — should fuel more work, more risky investments and, what is most important policy-wise, more private employment. This action, overall, is far more effective and attractive than the highly doubtful, potentially explosive inflationary alternative — the Federal Reserve’s proposed quantitative easing. After all, banks are currently flooded with liquidity. At least let them exhaust this source before turning on the spigot of $600 billion in added resources. Beranek is professor emeritus of financial economics at the University of Georgia.

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