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Should we really care about inequality?

Apr 22,2018 - Last updated at Apr 22,2018

What does inequality mean for growth? That is a question economists struggle with. But while the social science debate rages on, policymakers face another quandary altogether: does the answer even matter?

I do not believe it does.

Economic policies in the real world are nuanced and site-specific, making the search for a single answer to the question of how, and how much, inequality affects growth a Sisyphean task. Rather than concerning themselves with how to balance growth and inequality, policymakers would be better off focusing on how policies impact average incomes and other welfare indicators.

Policies that simultaneously boost growth and reduce inequality are the easiest to evaluate and the most advantageous to adopt. These types of approaches, what I call “all good things go together” policies, are easily applied to education, but can also work in other sectors of the economy that are squeezed by imperfect competition. More vigorous antitrust policies, for example, could boost efficiency and improve income distribution.

It is far more difficult to evaluate policies that involve a tradeoff between growth and inequality. A simple example illuminates the tradeoffs. I will analyse a 10 per cent reduction in labour taxes paid for by a lump-sum tax using a neo-classical Ramsey growth model. Under these parameters, average output increases by 1 per cent.

But when checked against the numbers that really matter, the outcomes are less rosy.

Applying this model to the distribution of US household incomes in 2010, I found that while most households would benefit from higher pre-tax income, two-thirds would also face higher taxes. In addition, households would have less leisure. As a result, around 60 per cent of households were worse off because of the tax change, even though average household income went up, driven by gains at the top.

This scenario does not answer the question of whether the tax policy is a good idea. But most policymakers would likely object if they understood that growth would be achieved by higher taxes on two-thirds of their constituents and that voters would end up working harder to earn the same money.

Social scientists should continue to ask whether inequality is good or bad for economic growth. But policymakers should focus more on how to achieve their economic goals. For them, the answer may be to obsess less over aggregate data and academic debates, and more on how decisions impact real people.

 

Jason Furman, professor of the Practice of Economic Policy at the Harvard Kennedy School and senior fellow at the Peterson Institute for International Economics, was chairman of president Barack Obama’s council of economic advisers from 2013-2017. Copyright: Project Syndicate, 2018.
www.project-syndicate.org

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