Wednesday, November 15, 2006

What should the Dems do?

Today's op-ed by the Senator-elect Webb got me thinking. The piece is filled with standard Democratic hand-wringing about rising inequality, but as Arnold Kling points out, it is essentially devoid of policy proposals.

Free-market economists like me are typically less concerned about rising inequality; some, like Gary Becker, go so far as to call it a "favorable development." But let's suppose for a moment that a free-market economist were hired by the Dems to offer policy advice. If the boss's goal is to reduce income inequality, what is the best way to do that?

The standard Democratic fare would be quickly rejected. Erecting barriers to trade, raising the minimum wage, encouraging the cartelization of labor via unions, and bashing Wal-Mart are inefficient and poorly targeted ways to redistribute income.

The tax system is probably the best vehicle to accomplish the Dems' goal. One possibility would be to reduce the payroll tax rate and to make up the lost revenue by increasing, or perhaps even eliminating, the cap on taxable payroll. That would benefit, approximately, the bottom 90 percent of the income distribution.

This policy change would, of course, have an efficiency cost. By raising taxes on taxpayers who already face the highest tax rates, the deadweight losses of the tax system would surely rise. But almost any attempt to achieve a more equal distribution of income would entail efficiency costs. The Dems' goal should be to minimize the efficiency cost for any given amount of redistribution. And that is most likely accomplished through the tax system rather than by more heavy-handed market interventions.