18 chapter taxation and redistribution public sector economics: the role of government in the...

18CHAPTER

Taxation and Redistribution

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe

18-2


Taxation and Taxation and RedistributionRedistribution

Over half the federal budget goes Over half the federal budget goes toward redistributiontoward redistribution

Directly redistributive programs Directly redistributive programs include:include: Social securitySocial security MedicaidMedicaid Unemployment compensationUnemployment compensation

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Principles of Taxation Principles of Taxation and Redistributionand Redistribution

Taxes pay for public sector outputTaxes pay for public sector output Frequently, taxation and spending Frequently, taxation and spending

pursue income equalitypursue income equality Goal of redistributive programs Goal of redistributive programs

Use resources of some taxpayers to Use resources of some taxpayers to improve welfare of othersimprove welfare of others

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Equality as a Social GoalEquality as a Social Goal

Motivations underlying redistributive Motivations underlying redistributive programs:programs: Create more income equalityCreate more income equality Improve welfare of least well offImprove welfare of least well off

Redistributive programs targeted Redistributive programs targeted domesticallydomestically

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Equality of Opportunity Equality of Opportunity and Equality of Resultsand Equality of Results

Equal opportunity Equal opportunity Everyone starts with same chanceEveryone starts with same chance Desire for game with fair rulesDesire for game with fair rules

Fair rules Fair rules Rules that can be agreed uponRules that can be agreed upon

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Goal of EqualityGoal of Equality

Equality of opportunity is a Equality of opportunity is a normative goalnormative goal

Many individuals feel that less than Many individuals feel that less than equitable results of opportunity equitable results of opportunity warrant income redistribution warrant income redistribution policiespolicies

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Utilitarian JustificationsUtilitarian Justifications

Social UtilitySocial Utility Sum of individual utilities in a societySum of individual utilities in a society

Maximize social utility Maximize social utility Transfer income from high to low Transfer income from high to low

income individualsincome individuals Social welfare function Social welfare function

Utility function for society as a wholeUtility function for society as a whole Admits possibility that it can be Admits possibility that it can be

increased by income transfersincreased by income transfers

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Utility Maximization of Utility Maximization of Those Least Well OffThose Least Well Off

Focuses on those at bottom of Focuses on those at bottom of societysociety

Recognizes disincentives toward Recognizes disincentives toward earning income inherent in earning income inherent in redistribution schemesredistribution schemes

Suggests taxing high-income earners Suggests taxing high-income earners and redistributing to low-income and redistributing to low-income earners until utility of person with earners until utility of person with lowest well-being maximizedlowest well-being maximized

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Charity as a Collective Charity as a Collective Consumption GoodConsumption Good

Will be underprovided if left to Will be underprovided if left to private sectorprivate sector

Charitable Giving as a Pareto Charitable Giving as a Pareto Superior MoveSuperior Move

Charity increases standard of living Charity increases standard of living of less fortunateof less fortunate

Givers and recipients made better offGivers and recipients made better off

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Incentive to Free RideIncentive to Free Ride

Charity has some characteristics of a Charity has some characteristics of a public goodpublic good

Potential givers have incentive to Potential givers have incentive to become free ridersbecome free riders

Role of government to overcome free Role of government to overcome free rider problem and provide optimal rider problem and provide optimal amount of redistributionamount of redistribution

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Redistribution as Redistribution as InsuranceInsurance

Acts as type of income insuranceActs as type of income insurance Partially protects people from having Partially protects people from having

low incomeslow incomes Premiums paid in high-income years Premiums paid in high-income years

exchanged for payments in low-exchanged for payments in low-income yearsincome years

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Progressive Taxation and Progressive Taxation and Wage AdjustmentWage Adjustment

Market adjustments to wage Market adjustments to wage structure partially offset structure partially offset redistributive effects of taxationredistributive effects of taxation

More progressive tax structure raises More progressive tax structure raises pretax income of high-income pretax income of high-income workersworkers Lowers pretax income of low-income Lowers pretax income of low-income

workersworkers

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Progressive Taxation and Progressive Taxation and Wage AdjustmentWage Adjustment

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Distributive GovernmentDistributive Government

Shift of government spending toward Shift of government spending toward redistributional programsredistributional programs

Increasing proportion of population Increasing proportion of population dependent on government for their dependent on government for their incomesincomes

More worthwhile for special interests More worthwhile for special interests to lobby governmentto lobby government

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Incentive Structure of Incentive Structure of Government ProgramsGovernment Programs

Do government programs do what Do government programs do what they are supposed to do?they are supposed to do?

Welfare programs provide incentives Welfare programs provide incentives to remain unemployedto remain unemployed

Programs create transitional gainsPrograms create transitional gains Abolishing programs results in Abolishing programs results in

transitional lossestransitional losses

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Incentive Structure of Incentive Structure of Government ProgramsGovernment Programs

A Price Floor

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Redistributive Programs Redistributive Programs and the Poorand the Poor

Short run Short run Can reduce income of poorCan reduce income of poor

Long run Long run More difficult to escape povertyMore difficult to escape poverty

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Incentives to Earn Less Incentives to Earn Less IncomeIncome

Redistributive income Redistributive income Payments to lower-income individualsPayments to lower-income individuals

Higher income tax rates for welfare Higher income tax rates for welfare recipients if benefits lost included in recipients if benefits lost included in addition to taxes paidaddition to taxes paid

Incentive structure encourages Incentive structure encourages people to remain on welfarepeople to remain on welfare

May create poverty by creating May create poverty by creating permanent class of welfare recipientspermanent class of welfare recipients

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Hard-Core Poor and Hard-Core Poor and Marginal PoorMarginal Poor

Hard-core poor Hard-core poor Poor because of injuries, disease, or disabilityPoor because of injuries, disease, or disability

Marginal poor Marginal poor Poor because of lack of education, pregnancy, Poor because of lack of education, pregnancy,

economic downturneconomic downturn In position to improve economic statusIn position to improve economic status

Goal of redistributive programs to help Goal of redistributive programs to help hard-core poorhard-core poor

Help marginal poor in the processHelp marginal poor in the process

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Growing Dependency on Growing Dependency on Government ProgramsGovernment Programs

Welfare dependency Welfare dependency Marginal poor who gradually become Marginal poor who gradually become

hard-core poorhard-core poor

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Politics of RedistributionPolitics of Redistribution

Redistribution programs becoming Redistribution programs becoming larger portion of government’s larger portion of government’s budgetbudget Increases incentives for special interests Increases incentives for special interests

to lobby governmentto lobby government Establishment of redistribution Establishment of redistribution

programs creates welfare industryprograms creates welfare industry

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Administrator IncentivesAdministrator Incentives

Bureaucrats have incentive to Bureaucrats have incentive to maximize budgets of their bureausmaximize budgets of their bureaus

Negative effect of government Negative effect of government programs result of rational self-programs result of rational self-interests of government interests of government administrators administrators

Political incentives can cause Political incentives can cause inefficient programs to be favored inefficient programs to be favored over potentially effective onesover potentially effective ones

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Goals of RedistributionGoals of Redistribution

In 2000, a family of 4 would have In 2000, a family of 4 would have received $87,000 if transfers equally received $87,000 if transfers equally divided among poorest 20% of divided among poorest 20% of citizens.citizens.

Why does poverty remain?Why does poverty remain?

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The Politics of The Politics of RedistributionRedistribution

Much income redistributed from Much income redistributed from middle incomes to middle incomesmiddle incomes to middle incomes

Much redistribution not targeted Much redistribution not targeted specifically to needyspecifically to needy

Redistribution programs subject to Redistribution programs subject to interest group pressureinterest group pressure

Redistribution programs designed Redistribution programs designed through political processthrough political process

18 chapter taxation and redistribution public sector economics: the role of government in the...

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