Federal Programs Keep People Poor

We can't tax our way to greater income mobility

Many very rich people in America—including a certain presidential front-runner on the Republican side—were born into their wealth. But others started with nothing and, through talent and effort, worked their way to the top of the heap. From Andrew Carnegie to Sam Walton to Oprah Winfrey, our history is bursting with rags-to-riches stories of people who achieved "the American dream." Winfrey was born dirt poor to unwed teenage parents. She suffered abuse, had to leave her home, and got pregnant at 14, only to lose the child. None of that stopped her from rising to head a multimillion-dollar media operation.

The idea that anything is possible here has attracted millions of immigrants to U.S. shores—but increasingly the political left has fretted that "income mobility," or the ability to rise from modest beginnings, is faltering in America. In response, Democratic politicians such as Hillary Clinton and Bernie Sanders are calling for policies to address the absence of "opportunity" through higher taxes on the rich and more wealth redistribution to the poor.

So how does the U.S. actually compare to the rest of the world? In November 2015, Manhattan Institute economist Scott Winship published a two-part series addressing that very question, summarizing his findings like this: "The new evidence does not suggest that the U.S. has especially high economic mobility, but it does indicate that America is not the international laggard that has been portrayed by earlier studies."

That's hardly a ringing endorsement of the status quo. But as Winship says in an email, "Proceeding from the mistaken view that there is no opportunity for anyone will lead policy makers to misdirect scarce resources—including money and attention—away from those who really do face long odds against success." While Americans are better off than their counterparts in other countries on a number of metrics, in some areas, such as mobility among black men, our progress is abysmal.

We ought to be concerned when a segment of the population falls behind. But it turns out that many of the policies Clinton and Sanders demand in the name of helping the less fortunate would very likely make the problem worse.

Clinton plans to raise taxes mostly on the top 1 percent of Americans. Sanders' plan meanwhile would significantly increase the rates of federal income, payroll, business, and estate taxes, and impose new excise taxes on financial transactions and carbon. He also wants to tax capital gains and dividends at ordinary income rates for households that make over $250,000. Under his plan, all income groups would feel the pinch, though most of the money would come from high-income households.

But the candidates' ambitions may not produce the benefits they expect. As the liberal Tax Policy Center notes, for example, Sanders' "proposals would raise taxes on work, saving, and investment, in some cases to rates well beyond recent historical experience in the U.S."

Increasing taxes on savings and investments has the unfortunate effect of hurting poor people while rich folks benefit. That's because when you raise taxes on something, you usually get less of it. When fewer people are willing to save or invest their money, it reduces the capital stock (that is, the amount of factories and equipment available to workers). This makes people less productive over time—imagine trying to do your job without access to a computer!—which eventually depresses wages. And since there's now less capital, the return on what capital remains increases. As Andrew Lundeen from the Tax Foundation notes, the result is that "wage earners make less and capital owners make more." Stated otherwise, workers' mobility goes down and inequality goes up.

Beyond the unintended effects of the taxes themselves, many liberals support policies (such as universal health care, a dramatic increase in the federal minimum wage, and mandatory paid family leave) that might sound good in theory but would almost certainly backfire. We're already seeing just that play out with Obamacare. In 2014, the Congressional Budget Office—Congress' official fiscal scorekeeper—revised its original estimate to report that because of the law, by 2024 the equivalent of 2.5 million Americans who were otherwise willing and able to work will have exited the labor force.

Those findings were based in part on the work of economist Casey Mulligan of the University of Chicago. Mulligan has found that government spending programs tied to income (that is, programs that are meant to benefit low-income workers only) make work less remunerative for poor Americans. When the government takes away a person's benefits as his income goes up, it has the same effect as a direct tax. And remember, when you tax something, you usually get less of it. That means these programs can actually hinder income mobility: In order to continue receiving their government cash, individuals are forced to limit the amount they earn. Thus, they have an incentive not to try to climb the income ladder by putting in extra hours or signing up for job training and educational programs.

Sanders' plan was likely influenced by the acclaimed work of liberal economists Peter Diamond and Emmanuel Saez, whose research suggests that an increase in marginal rates of taxation on the wealthy to somewhere between 50 and 70 percent would maximize revenue for the government without penalizing people who want to work.

Indeed, the literature shows that in the short term, marginal rate increases don't have much of an effect on the amount of labor supplied by the typical full-time-employed man in the 30–50 age range. However, this finding doesn't hold for secondary earners, such as the working wives of high-income earners. And as Nobel laureate Edward Prescott has shown, the impact of higher tax rates on the labor supply is most visible in the long run, because it often takes the form of earlier retirement. This effect is particularly strong if the higher tax rates are paired with a generous welfare state like the one Sanders wants.

High-income earners may also respond to tax hikes by asking for more generous employer-sponsored health insurance and other untaxed fringe benefits, evading taxes by underreporting their income, or doing their business outside the United States. At the end of the day, when incentives change, so does people's behavior.

Recent papers by Cornell economist Karel Mertens further challenge the common belief that raising or lowering taxes only affects people at the top of the income distribution. Mertens' work shows that "marginal rate cuts lead to increases in real [gross domestic product] and declines in unemployment," and that "tax cuts targeting the top 1% alone have positive effects on economic activity and incomes outside of the top 1%." This is true even if the cuts increase pre-tax levels of income inequality.To repeat: Cutting marginal rates on the top 1 percent has a positive impact on lower-income workers.

Clinton and Sanders are right to be concerned about the mobility of poor Americans. But increased opportunity comes when we cultivate a robust, growing economy. To accomplish that, we need to eliminate the policies that are holding back low-income earners in general and black males in particular. That means championing school choice, reforming our criminal justice system, and ending the easy-money policies that have prevailed in Washington for a decade but mostly benefit the rich people on Wall Street who actually own most of the stocks.

There are many ways we can help the poor (and the middle class, for that matter); overtaxing the rich—thereby making it less appealing to be the next Oprah Winfrey or Andrew Carnegie—is not one of them.