Greg Mankiw, Harvard prof, former CEA chair, and most importantly famed econblogger wrote this very fine paper several years back. Though there's a bit of math, overall the paper is very common-sensical, and quite readable. Here's my favorite bit:

Proposition 3: Government debt increases steady-state inequality.

Although... government debt does not affect the steady-state capital stock and national income, government debt does influence the distribution of income and consumption in the savers-spenders model... A higher level of debt means a higher level of taxation to pay for the interest payments on the debt. The taxes fall on both spenders and savers, but the interest payments go entirely to the savers. Thus, a higher level of debt raises the steady-state income and consumption of the savers and lowers the steady-state income and consumption and the spenders. The spenders, however, already had lower income and consumption than the savers (for only the savers earn capital income). Thus, a higher level of debt raises steady-state inequality in income and consumption.

This is a very straightforward argument: The government borrowing today to tax tomorrow is a non-event, if the monies not taxed today are all invested at a return that precisely covers the deferred taxation. But if "savers" invest the funds not taxed while "spenders" consume more than they would have, the savers are left unaffected but the spenders are left worse off when the bill comes due. (In Mankiw's model, savers are not unaffected, but positively gain, as higher current consumption by spenders and government yields rising returns to savers, who invest and earn more than they otherwise would have.)

Given all the recent sturm und drang over inequality and the degree to which it can be accounted for by public policy, I'm surprised that this argument hasn't featured more prominently. Given the United States' current fiscal policy and the concern over inequality today, you'd think the idea of deficits exacerbating inequality would really bite.

Some comments:

  1. The effect that Mankiw describes would be lagged: deficit spending now yields greater inequality over time.
  2. It is somewhat insidious, in that deficit spending today increases consumption equality today, as typically poorer spenders consume more than they otherwise would, and live more like wealthier savers.
  3. To counteract this effect, having a progressive tax system isn't enough. A government that causes inequality through deficit spending would have to increase the progressivity of taxation in proportion to its borrowing in order to undo the increased inequality. Progressivity here would mean adjusting effective tax rates paid by cohorts. (The proportion of total taxes paid by spenders would increase even without policy changes, as a reflection of growing inequality.)

I'd love to see Mankiw extend his model to include not only domestic spenders and savers, but also foreign savers not subject to many US taxes. Also, if monetization of government debt is permitted as an alternative to (or a form of) taxation, how would that affect the relative wealth of domestic spenders, domestic savers, and foreign savers?

Note: Mankiw issued a minor correction for this paper, though it does not affect the argument discussed above.

Some Recent(-ish) Inequality Posts

Steve Randy Waldman — Sunday September 17, 2006 at 3:18pm permalink
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