The strong showing by Democrats in the recent elections is causing a debate about how aggressive the party should be in pushing a program of making everyday life more affordable for the middle and working classes. Should the party pursue policies surrounding universal childcare, free higher education, and greater subsidies for healthcare expenses and housing funded by much higher taxes on business and the more affluent?
The logical answer is an emphatic “no.”
The facts about what happens when government becomes more involved in the economy, and when it provides consumption subsidies for middle-class and working-class households, should make Democratic elites think twice before jumping off the deep end on redistribution. The facts are beyond debate. Economic growth slows as the size of the government’s role in an economy grows. Look at the countries of Europe, which are rapidly going bankrupt because economic growth has slowed so dramatically over the past two decades, but social welfare spending continues to increase.
This means redistribution and economic growth are incompatible. Strong economic growth provides the resources so that everyone can share in the American dream of a continuous rise in the standard of living. Adjusted for inflation, in 1967, only 5% of American households enjoyed annual incomes of $150,000 and higher. Today, about 35% of the country’s households have incomes of $150,000 and higher.
Unlike the countries of Europe, the United States has relatively low taxes on business and, at least in most states, nonconfiscatory taxes on the most affluent. It is important to note, however, that the U.S. has a very progressive tax system. Until now, voters have preferred pro-growth policies to policies of redistribution. The benefits of this choice are obvious when comparing the per capita incomes of the wealthy countries of Europe to the U.S. Household incomes in the U.S. are 30 to 50% higher than in Europe.
A recent paper from the National Bureau of Economic Research explains that redistribution does not work. Redistributive income policies reduce real incomes but have only a marginal effect on income inequality. Voices that clamor for greater income redistribution always sound compassionate and reasonable. This probably explains the election of an avowed socialist to be mayor of New York City. But economics is not a morality play. Economics is a system of incentives. And incentives matter a lot. When the government takes more from those who produce and invest in order to subsidize those who don’t, it undermines the very engine that drives prosperity.
People respond to incentives. Nobel Laureate James Mirrlees, deceased, explained that from the standpoint of economic growth, the most economically efficient tax rate on the most productive members of our society is zero. Rather than raising taxes on the most productive to fund redistribution programs, our political elites should be reducing taxes on productive high earners and replacing the income tax with a consumption tax.
Economic growth depends on savings, investment, and risk-taking. Redistribution, through higher taxes, transfer payments, or wage controls, discourages all three. When capital is taxed more heavily, there is less of it. When marginal tax rates climb, entrepreneurship declines. When welfare expands, labor participation falls. Over time, the productive share of the economy shrinks while the dependent share grows.
Redistribution doesn’t just slow economic growth. It changes the nature of a society. A culture of personal responsibility and striving is replaced by a culture of entitlement. In the U.S., the entitlement culture is bankrupting the nation. The U.S. is borrowing to fund entitlement programs, which are not sustainable. Debt is piled on debt. Interest rates are higher. Home ownership becomes unaffordable.
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Everyone’s standard of living depends on growth. A rising economy lifts all boats. Everyone enjoys higher wages. Opportunity grows. Social mobility increases. The best economic and social policies promote personal responsibility, hard work, and the liberty to live as each person chooses.
Instead of redistributing income, politicians should focus on expanding opportunity: improve education, reduce regulatory barriers, reward work, and keep taxes predictable and low. Growth, not redistribution, is what provides the funds for compassion.
James Rogan is a former U.S. foreign service officer who has worked in finance and law for 30 years. He writes a daily note on the markets, politics, and society. He can be followed on X and reached at [email protected].
