What should be done about income inequality? That basic question underlies the arguments hashed out in the supercommittee and promises to be a central issue in the presidential campaign.
Supercommittee Democrats argue that income inequality has been increasing and can be at least partially reversed by higher tax rates on high earners. They refused to agree on any deal that didn’t include such tax increases.
Supercommittee Republicans offered a plan to eliminate tax preferences and reduce tax rates, as in the 1986 bipartisan tax reform. They argued that high tax rates would squelch economic growth.
They didn’t make the case that their proposals would also address income inequality. But House Budget Committee Chairman Paul Ryan, in a 17-page paper based largely on a Congressional Budget Office analysis of income trends between 1979 and 2007, has done so.
Ryan, a Republican from Wisconsin, makes the point that the government redistributes income not only through taxes but also through transfer payments, including Social Security, Medicare, food stamps, and unemployment benefits. The CBO study helpfully measures income, adjusted for inflation, after taxes and after such transfer payments.
Many may find the results of the CBO study surprising. It turns out, Ryan reports, that federal income taxes (including the refundable Earned Income Tax Credit) actually decreased income inequality slightly between 1979 and 2007, while the federal payroll taxes that supposedly fund Social Security and Medicare slightly increased income inequality. That’s despite the fact that income tax rates are lower than in 1979 and payroll taxes higher.
Perhaps even more surprising, federal transfer payments have done much more to increase income inequality than federal taxes. That’s because, in Ryan’s words, “the distribution of government transfers has moved away from households in the lower part of the income scale. For instance, in 1979, households in the lowest income quintile received 54 percent of all transfer payments. In 2007, those households received just 36 percent of transfers.”
In effect, Social Security and Medicare have been transferring money from low-earning young people (who don’t pay income taxes but are hit by the payroll tax) to increasingly affluent old people.
The Democrats, perhaps following the polls and focus groups, have been protecting these entitlement programs, which have done more to increase income inequality than the Reagan and Bush tax cuts put together.
Ryan makes three more points that may strike many as counterintuitive.