“Give me a one-handed economist!”
The demand came from a frustrated Harry Truman. The President complained, by way of explanation, “All my economists say, ‘on the one hand . . . on the other . . . ’” Trade-offs are at the center of economics. While economic advisors are not advocates of inaction or the status quo, they do take pleasure in pointing out the unintended consequences of policies that fail to consider human incentives. Economics, after all, presents itself as a positive science, not an explicitly normative discipline. It studies people’s actual behavior, not the way people ought to behave.
And this is especially true when designing policies to reduce economic inequality, which may partly explain the ongoing political polarization worldwide. For starters, the wealthy will not let go of their privileges so easily. More importantly, redistributing privileges may not unfold as planned, since taking resources away from wealthy entrepreneurs and innovators may weaken their incentive to produce anything that would lead to prosperity for others in the future.
Yet, do we really believe that visionary entrepreneurs and innovators will drastically change their behavior if they see their wealth taxed? The answer is, we do not know. Despite innovative proposals, such as the “global corporate tax,” which would prevent corporations from fleeing elsewhere in response to higher taxes, no rigorous studies on the effects of wealth taxes have been conducted in advanced economies. Hence, while we wait for academic evidence to provide some concrete insights on this matter we can only rely on our knowledge of the effects of labor income taxation on labor supply.
High labor income tax rates may, in fact, lower tax revenues. This celebrated doctrine of public economics rests on the assumption that talented workers, faced with high tax rates, will lose the incentive to work hard and increase their pre-tax income. According to this scenario the tax base would decrease. When an increase in the tax rate leads to a reduction in tax revenues, economists say that the tax rate is above the Laffer rate, in honor of the American professor Arthur Laffer, the first economist to propose this idea.
But the current tax rate on the super-rich may be far from the Laffer rate in the United States, with billionaires paying lower tax rates than the working class. In fact, some forms of wealth currently are tax free. So, there should be no harm in raising the tax rate on wealth, right? Well, not quite. Even if the current tax rate does not threaten overall tax revenue, any tax increase may dampen, little by little, beneficial economic investments in areas of growth such as the development of new technologies. Diminishing the accumulation of wealth, in turn, hurts society.
The bottom line? Policymakers must be careful in assuming that heavily taxing the ultra-rich is a viable solution to inequality: the remedy may prove worse than the illness itself.
That said, apart from redistribution efforts, two types of policies may prove successful in reducing economic inequality and its unsettling effects on society. The first of these is commonly known in economics as “social insurance,” a set of mechanisms that minimize the pernicious effects of negative income shocks, such as catastrophic illnesses, on affected households. The second group includes those policies oriented toward fostering human development, including early childhood interventions and adult education.
A prominent example of social insurance is universal healthcare coverage, which reduces the risk of financial ruin by protecting families against large medical bills. Although costly, its implementation is desirable because people without coverage impose hidden costs on the economy, such as diminished productivity and increased costs of remedial care in the future. This policy is not only economically desirable, it is also in accord with protecting the basic dignity of every person.
Another “social insurance” policy proposal, one that has attracted significant attention in the US political arena, is the so-called universal basic income (UBI). At its core, this proposal aims to provide a cash grant large enough for people to live on. It is not phased out as incomes rise, and it is made available to the entire population. The popularity of UBI results from the widespread fear that robots and artificial intelligence will eventually replace human work.
Attractive and innovative as it is, UBI would be extremely expensive, and it would not be a substitute for work satisfaction—even bottom-line economists recognize that individuals derive life satisfaction from their profession. Hence, universal health care may be a more realistic first step in guarding human dignity, as it has already been implemented in many high-income countries, including Canada, Australia, and the United Kingdom.
Early childhood interventions
Apart from social insurance, many are the policies that can be implemented to help adults, including raising the minimum wage, allowing the earned income tax credit, and providing welfare. But as in any other field, the true hope is in children. Luckily, early childhood interventions have been shown to have extremely high returns, perhaps the highest among all available policies. This is because their effects compound over the life cycle. Furthermore, they are among the very few policies where the often-competing goals of equity and efficiency are perfectly well aligned, as flourishing adults become also more efficient economic agents.
And these interventions are relatively straightforward to implement. Modal programs provide around two hours of preschool programming each weekday during the school year and weekly home visits to beneficiary families aimed at teaching them parenting techniques, such as practicing language activities and playing with children at home. Curricula are broadly based on high-quality topics related to cognitive and socio-emotional development.
The most substantive challenge currently faced by these interventions is the issue of scaling up their benefits. Most successful early childhood programs have been conducted in rather controlled environments and with a small number of children. The current problem for policymakers is to design interventions that can be scaled up without compromising the quality of service. In fact, most of the existing large-scale interventions have been shown to have small, or even negligible effects. Evidence is starting to mount that pedagogy really matters and that quality dilutes with the size of the programs.
Finally, there is a group of policies to better-prepare adults for the labor market. In particular, training programs have acquired new vigor in light of recent episodes of automation that have propelled many clerical workers into unemployment. At the current pace of technological progress, it is likely that occupations will continue to become obsolete. Hence, workers will have to accept the challenges of lifelong learning. Increasingly, training programs will be needed to insert the youth into the labor market and reinsert older workers whose occupations become obsolete.
A longstanding tradition in economics shows that, depending on the type of program and the context of implementation, training programs have mixed success in raising earnings and employment opportunities for beneficiaries. High-quality research shows that both firm apprenticeships and vocational training increase employment probabilities and earnings, but vocational training benefits workers at almost twice the rate of firm-provided training. The reason is that certifiability plays an essential role in proving a certain skill level to potential employers. Additionally, training programs seem to be more successful in developing countries, where apprenticeships may lead to insertion into the formal sector.
Moderate tax redistribution, universal health care, early childhood interventions, and adult education are viable solutions to mitigate the structural causes of economic inequality. Irrespective of individual views on the ideal role of other policies aimed at helping struggling households, such as welfare, these four sets of policies are likely to have many more benefits than costs, making them economically feasible. Furthermore, these sets of policies place human dignity and development at the front and center of policymaking.
Kellogg Faculty Fellow Alejandro Estefan is assistant professor of development economics in the Keough School of Global Affairs at the University of Notre Dame. Belén Carriedo, Uriel Galace, Laura Guerra, Shadwa Ibrahim, and Eleanor Jones are second-year students in the Keough School’s Master of Global Affairs program.