After IMF inequality report, what’s next for US tax policy?

After IMF inequality report, what’s next for US tax policy?
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The IMF has joined in on the income inequality debate, arguing that rising inequality is depressing economic growth and fueling political instability. Although the issue remains polarizing in the United States, there is some evidence of a shift towards bipartisan consensus.

From protests on Wall Street to uprisings in Nigeria, the fierce debate over income inequality has moved in recent months from city streets to legislative offices and global financial institutions. The growing gap between rich and poor has been defined by US President Barack Obama and Pope Francis as “the defining issue of the 21st century,” with inequality returning to levels not seen since before the Great Depression.

Adding fire to the flame of protestors is a recent paper by the International Monetary Fund, which warns that rising income inequality is depressing economic growth and fueling political instability.

Challenging long-held economic assumptions

According to IMF Managing Director Christine Lagarde, rising inequality has created “an economy of exclusion, and a wasteland of discarded potential.” With their new paper, the world’s top economic institution is testing the long-held notion that lowering taxes on the rich and corporations will spur investments and drive growth throughout the economy. With effective social policies in place, the lower and lower-middle classes would eventually realize the benefits of these investments.

But research by the Organization for Economic Cooperation and Development (OECD) finds that progressive fiscal policies and redistribution will lead to faster and more durable long-term growth. Among developed economies, direct income taxes and cash transfers have worked together to decrease inequality by close to 30 percent over the past two decades.

Median top personal income-tax rates in developed economies, however, have halved globally since the mid-1980s. According to the OECD, the shares of the richest 1 per cent in total pre-tax income range between 7 per cent in Denmark to as much as 20 percent in the United States. Thus, as the rich continue to capture a disproportionate share of overall income, top income tax rates have fallen rapidly.

Less taxable income means less state money can be channeled to social programs that benefit the poor, depriving many people access to education assistance, health insurance, and unemployment benefits. Average tax ratios in Latin America, for example, stand at just 15 percent. With budgets already constrained in many Latin American countries, outlays to social programs take a backseat to spending on fuel subsidies.

The IMF argues that levying higher taxes on the rich and improving social assistance programs can mitigate and reverse the trend of income disparity, and drive long-term economic growth. Redistribution and spending on social programs can help break the inter-generational transmission of poverty, resulting in lower taxes and less cash transfers in the future.

What to do about rising inequality, however, continues to be a polarizing issue, especially in the United States.

America hampered by partisan polarization

While most Americans believe inequality of wealth is a growing problem, political parties remain sharply divided on fundamentals. Democrats tend to focus on the sharp breakaway gains of the rich, declining middle-class incomes, and stagnant social mobility. Republicans, admitting that inequality has grown, argue that a certain degree of inequality should be expected when the opportunity to advance in society is widely shared.

Perhaps the most polarizing debate has been over revamping tax policies to help spur investment and growth. According to the Pew Research Center, 75 percent of Democrats believe the best way to narrow the gap between rich and poor is to raise taxes on the wealthy and expand antipoverty programs. 59 per cent of Republicans refuse this notion, however, arguing that raising taxes on the wealthy and corporations would discourage investment and depress economic growth.

However, amongst sharp debates over taxes and economics, there is some evidence that Democrats and Republicans are converging on the issues of poverty and opportunity.

GOP leaders and Presidential aspirants have made poverty and social mobility a key talking point in the run up to November midterm elections. Paul Ryan, chairman of the House Budget Committee, has held three committee hearings on poverty so far this year. Florida Senator Marco Rubio and Virginia Representative Eric Cantor have spoken out on income inequality as well, arguing for education and social reforms to reduce poverty.

Although a bipartisan consensus seems to be brewing, disagreements over taxes and fundamentals will likely thwart any substantial policies designed to slow and narrow the inequality gap this year. The IMF’s guidance is an important development, however, for it frames the income inequality debate as a matter of economic growth and stability rather than merely a social and political conflict.

Categories: Economics, North America

About Author

Rami Ayyub

Rami is an analyst with a US Defense and Space firm, where he works in strategic planning and finance for Civil and Defense programs. He holds Bachelor degrees in Finance and Classical Music from the University of Maryland, College Park.