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Redistribution of Income Depends on the Baseline

By: Gerald Prante

There has been a lot of talk lately about redistributing income, and whether or not raising taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es on high-income people to give tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. s (which are essentially the equivalent of government spending) to lower-and middle-income households is proper fiscal policy.

McCain and his campaign have had lots of labels for it over the past few weeks: redistribution, welfare, socialism, handouts, etc. Obama himself has said he favors "sharing the wealth." So let's get to the heart of the matter and ask is this redistribution and is it proper fiscal policy?

I'd say that it is redistribution, especially given that Obama's defense of his policies have included using the term "share the wealth" explicitly. One could make a separate case that says currently, high-income households are paying too little in taxes in accordance with the benefits that they receive from government spending (absent any value of the public good of redistribution). That's one argument that someone could use to justify Obama's policies. If that is true, then Obama's plan isn't about redistribution. In fact, if Obama believed in this justification for higher taxes on upper-income households, then he could actually make the case that his tax plan would be limiting the amount of redistribution because the view assumes that upper-income households aren't paying their fair share of the taxes in accordance with their benefits. In terms of economic efficiency though, his way of limiting the redistribution could be criticized (i.e. lump-sum payments to those at the bottom financed by higher marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. s for those at the top). Note that this all assumes government spending is not just wasting the money in the first place and is actually a value to society.

What Obama actually appears to be arguing is something a little different, which is that we are not redistributing enough. That is, there is some socially optimal level of government redistribution to those in lower-income groups that most economists and citizens would say exceeds zero. (That is, there is a public good from some redistribution in itself.) If you believe that this optimal level is below what we are currently redistributing, then one can justify greater amounts of redistribution.

Or you could believe that a combination of both of these is true.