Reihan: Pre-Tax Inequality

Will Wilkinson has a thought-provoking post on pre-tax income inequality in the US and Germany. Most of us are familiar with the fact that after-tax (or rather after taxes and transfers) income inequality is markedly higher in the US than in Germany. But pre-tax, the levels are roughly the same. A few weeks ago, I puzzled over this in a short post.

Keep in mind that Germany absorbed the DDR in 1989. At unification, the population of West Germany was at 63 million. The population of East Germany was 16 million. Massive transfers have failed to close the gap between the neue Lander and the more prosperous south and west, though I imagine intra-national migration has helped somewhat. In 2007, Germany has a population just above 82 million, which implies a population increase of 3 million over 18 years: negligible. At 300 million, the US population has increased by about 52 million since 1990. And of course "immigrants, legal and illegal, account for about 40 percent of population growth." (Let's treat this number as a guideline: it wasn't calculated for the increase between 1990 and 2007! But I imagine the actual result wouldn't be far off.) A large share of immigrants, like my parents and many of my friends, come from the developing world; and many of these immigrants are low-skill, a pattern that often persists into the next generation.

All this is to say that we do pretty well, and the Germans do pretty badly, in terms of inequality of market income. I don't know exactly what this means, but it struck me as worthy of note.

Well, Will has a straightforward interpretation.

But it seems to me to fit pretty well with the weak effect of the relationship between declining unions and rising inequality found in other research, and suggests that the structure of basic American political-economic institutions is not especially conducive to inegalitarian outcomes.

That sounds about right.

There are some on the left who want the US tax-and-transfer regime to be more generous towards the poor and lower-middle-class. And there are others who seek large-scale structural shifts in the US economy, shifts that aim to change the pre-tax balance of economic forces. I actually don't think it's obvious that we should exclusively pursue the first path. The idea of a "property-owning democracy," in which ownership of income-producing assets is spread far more evenly, is about this pre-tax balance. You might say it is about strengthening the relative bargaining position of the working poor. But I do think open labor markets are the wrong target. Far better to use wage subsidies and other tools like it than to adopt, say, centralized wage bargaining.

The Scandinavian settlement, favored by many on the left and which I find pretty attractive as well, is built on (a) broad-based taxes, (b) relatively open labor markets, (c) extremely low trade barriers, and, most importantly and most distinctively, (d) high-quality public services. We mustn't forget that (a) and (d) are closely related. As Peter Lindert has argued, the consumers of (d) tend to pay for (d) thanks to (a).

The implications, to my mind, are that (1) the federal government ought to and almost certainly will have a much larger role in guaranteeing high-quality healthcare for all Americans. After some political wrangling and rear-guard actions by the small-government right, this will become a consensus position: the thorny questions will be over the delivery of services and the extent of redistribution. Hopefully any reform will make the "hidden welfare state" less opaque. And (2) we will, sooner or later, move in the direction of a VAT.