Remediating Income Inequality at the State Level

While I agree with Elizabeth McNichol’s observation in her post at RealClearPolicy that state and local tax policies may exacerbate income inequality:

That’s because state policymakers, over the years, have tended to choose tax policies that favor the wealthy over the poor and favor corporations over workers. For example, most states rely heavily on sales taxes, which hit low-income families especially hard because they generally spend (rather than save or invest) most or all of their income.

I have reservations about her proposed remedies, which consist of avoiding cutting income taxes or increasing sales taxes and increasing the top marginal personal income tax rates:

tates can help push back against this trend by using tax policy to reduce inequality instead of worsening it. They can raise taxes on high-income households by boosting their top income tax rate and capping tax breaks for high-income taxpayers. They can also create or expand Earned Income Tax Credits for low- and middle-income workers, raise taxes on inherited wealth, and eliminate costly and ineffective tax breaks for corporations.

At the same time, states should avoid actions — such as cutting income taxes or raising sales taxes — that expand inequality by shifting more of the tax responsibility to lower-income residents. And they should avoid cutting taxes deeply without replacing the lost revenues, which could force drastic cuts in services such as schools, transportation, and public safety, which are the building blocks of shared prosperity.

Sadly, she presents no evidence for the effectiveness of her proposals and there may be a good reason for that: they aren’t particularly effective. If a more steeply graduated state income tax were a remedy for income inequality within the states, as a state’s top marginal tax rates increase you’d expect income inequality to decline. That hasn’t been the case in California, the state with the most highly graduated state income tax. The opposite has happened, if anything, suggesting either that other forces are just too much for tax policy to address or that the main effect of a steeply graduated income tax is to increase the return on investment for rent-seeking. When you add that California’s tax policy has resulted in its revenues becoming mercurial while its expenses are much more predictable, resulting in fiscal instability, it suggests that tax policy is just not a particularly effective tool in social engineering.

A more effective strategy might be to focus attention on the factors that are actually driving income inequality in the state.