Economic Prosperity Reduces Poverty, Wealth Redistribution Doesn't
Published in the Boulder Daily Camera, 10/2/11
The government just released data showing increasing poverty levels. A family of four making $22,350 is considered poor, which would, in many places, be considered middle class. But, this is America and we demand better. Political beliefs aside, we should all agree that it is in everyone’s interest to improve the lives of families now living in poverty.
How best to reduce poverty has been an ongoing debate for decades. In the end, it comes down to two approaches. First, we can reduce poverty by redistributing wealth from those who have more to those who have less. Second, we can reduce poverty by facilitating broad economic growth, thereby providing the impoverished with more opportunities for a better life.
Unfortunately, these two approaches are often in conflict. Government redistribution from the “haves” to the “have-nots” requires a progressive tax structure whereby the haves give more to the government who then redistributes it as cash or benefits to the have nots. For example, our current progressive tax structure has the top 10% of income earners pay 70% of all individual income taxes, 50% of Americans pay no income taxes at all, and some who pay no taxes receive tax “refunds.”
The downside of a progressive tax structure is that it discourages investment and risk taking, a principle acknowledged by economists of all stripes. Long-term economic growth requires entrepreneurs and businesses to take risks. Reduce the financial incentive for risk taking through progressive taxation, and fewer risks are taken. Over time, increases in productivity and innovation – the fuel for improved living standards – are diminished.
What have we learned over the past 75 years about how these two approaches reduce poverty? Let’s look at two examples; Germany between 1948 and 1992 and America between 1965 and 2000.
After the war, Germany was split. For the next 44 years, East Germany operated under communism with, effectively, extreme progressive taxation towards the explicit goal of societal income equality whereas West Germany had a slightly progressive tax structure. During this time, East Germany evolved into an economic basket case while West Germany became the third largest economy in the world. Poverty? In 1992, the income levels of the bottom 10% of East and West Germans were similar with the West German poor having slightly lower incomes than the East German poor. However, West Germans overall had about twice the income of East Germans. I was in Germany in 1993, both East and West, and the differences were stark. While there were probably other factors at play, one result of East Germans making income equality the driving economic principle was that virtually everyone was, by West German standards, poor.
The last four decades of the 20th century in America also provide insight into the merits of promoting wealth redistribution vs. economic prosperity. In 1965, the Federal government began the “War on Poverty” from which Medicare, Medicaid, VISTA, Head Start, and a generous welfare system emerged. From 1980 to 2000, in a new era of “personal responsibility,” the wealth redistribution aspects of many of these programs were diminished or eliminated. What happened to poverty levels when these wealth redistributive programs shrank or went away? From the time the War on Poverty began until 1980, the poverty level fluctuated between 10-15%. From 1980-2000, poverty levels stayed in the same 10-15% range - no change. However, what is stunning during that 35-year period is the strong connection between economic growth and poverty. During periods of healthy economic growth, poverty declined; during periods of tepid economic growth, poverty was largely unchanged; and during recessions, poverty increased. From these data, it is clear that national economic prosperity reduced poverty levels, whereas attempts at wealth redistribution had little, if any, effect.
A downside of emphasizing economic growth is that risk takers and investors who succeed become wealthy, which can create a wider gap between the rich and poor. So, even though we all may be better off in absolute terms, people at the middle and lower income levels may feel relatively poorer. This is a real issue, but one that, I believe, should be secondary to improving the lives of America’s poor.
The social safety nets we have created to eliminate Third World-like poverty are good for America. What we are debating today is not how to keep the poor fed, clothed, and housed, but how to bring the poor into the middle-class. We all want that to happen, and history is telling us that government policies that promote economic growth will help and wealth redistributive policies won’t. “Class warfare” may be good politics, but it won’t lift Americans out of poverty.
The government just released data showing increasing poverty levels. A family of four making $22,350 is considered poor, which would, in many places, be considered middle class. But, this is America and we demand better. Political beliefs aside, we should all agree that it is in everyone’s interest to improve the lives of families now living in poverty.
How best to reduce poverty has been an ongoing debate for decades. In the end, it comes down to two approaches. First, we can reduce poverty by redistributing wealth from those who have more to those who have less. Second, we can reduce poverty by facilitating broad economic growth, thereby providing the impoverished with more opportunities for a better life.
Unfortunately, these two approaches are often in conflict. Government redistribution from the “haves” to the “have-nots” requires a progressive tax structure whereby the haves give more to the government who then redistributes it as cash or benefits to the have nots. For example, our current progressive tax structure has the top 10% of income earners pay 70% of all individual income taxes, 50% of Americans pay no income taxes at all, and some who pay no taxes receive tax “refunds.”
The downside of a progressive tax structure is that it discourages investment and risk taking, a principle acknowledged by economists of all stripes. Long-term economic growth requires entrepreneurs and businesses to take risks. Reduce the financial incentive for risk taking through progressive taxation, and fewer risks are taken. Over time, increases in productivity and innovation – the fuel for improved living standards – are diminished.
What have we learned over the past 75 years about how these two approaches reduce poverty? Let’s look at two examples; Germany between 1948 and 1992 and America between 1965 and 2000.
After the war, Germany was split. For the next 44 years, East Germany operated under communism with, effectively, extreme progressive taxation towards the explicit goal of societal income equality whereas West Germany had a slightly progressive tax structure. During this time, East Germany evolved into an economic basket case while West Germany became the third largest economy in the world. Poverty? In 1992, the income levels of the bottom 10% of East and West Germans were similar with the West German poor having slightly lower incomes than the East German poor. However, West Germans overall had about twice the income of East Germans. I was in Germany in 1993, both East and West, and the differences were stark. While there were probably other factors at play, one result of East Germans making income equality the driving economic principle was that virtually everyone was, by West German standards, poor.
The last four decades of the 20th century in America also provide insight into the merits of promoting wealth redistribution vs. economic prosperity. In 1965, the Federal government began the “War on Poverty” from which Medicare, Medicaid, VISTA, Head Start, and a generous welfare system emerged. From 1980 to 2000, in a new era of “personal responsibility,” the wealth redistribution aspects of many of these programs were diminished or eliminated. What happened to poverty levels when these wealth redistributive programs shrank or went away? From the time the War on Poverty began until 1980, the poverty level fluctuated between 10-15%. From 1980-2000, poverty levels stayed in the same 10-15% range - no change. However, what is stunning during that 35-year period is the strong connection between economic growth and poverty. During periods of healthy economic growth, poverty declined; during periods of tepid economic growth, poverty was largely unchanged; and during recessions, poverty increased. From these data, it is clear that national economic prosperity reduced poverty levels, whereas attempts at wealth redistribution had little, if any, effect.
A downside of emphasizing economic growth is that risk takers and investors who succeed become wealthy, which can create a wider gap between the rich and poor. So, even though we all may be better off in absolute terms, people at the middle and lower income levels may feel relatively poorer. This is a real issue, but one that, I believe, should be secondary to improving the lives of America’s poor.
The social safety nets we have created to eliminate Third World-like poverty are good for America. What we are debating today is not how to keep the poor fed, clothed, and housed, but how to bring the poor into the middle-class. We all want that to happen, and history is telling us that government policies that promote economic growth will help and wealth redistributive policies won’t. “Class warfare” may be good politics, but it won’t lift Americans out of poverty.