The equity issues surrounding alternative tax policies are attracting more attention from academic economists. Wealth and income distributions are more skewed now than they have been since the turn of the 20th century. The “Occupy Wall Street Movement,” stagnant middle class wages, and rising public debt seems to guarantee that the rhetoric of class warfare will continue to make a comeback in common discussion.
In our paper we will investigate the apparent ineffectiveness of fiscal policy and how this might be related to the increase in wealth and income disparity. It is likely that increased spending and lower taxes will have less of a stimulative aggregate impact in an economy with a highly skewed distribution of income and wealth since marginal propensities to consume are likely to differ substantially across incomes. If spending raises incomes for the wealthy disproportionately (recall middle class income has been stagnant for roughly 40 years) and tax breaks benefit mainly those with high income and wealth the fiscal multiplier is likely to be significantly smaller. We plan to model fiscal policy using an optimizing representative agent model and motivate an empirical investigation of the impact of income and wealth inequality on the effectiveness of fiscal policy. The empirical analysis will use data sets similar to those used by Gemmell, Kneller and Sanz (2011) and Kuang, Englebrecht, and Gilley (2001). The empirical findings will have obvious policy relevance for the current tax (and government spending) policy debates both in the US and the Euro zone.
Gemmell, N., Kneller, R. and I. Sanz (2011), The timing and persistence of fiscal policy impacts on growth: evidence from OECD countries, The Economic Journal, 121, F33-F58.
Kuang,Y., Englebrecht, T.D. and O.W. Gilley (2011), A distributional analysis of the fair tax plan: Annual and lifetime income considerations, Southern Economic Journal, 78, 2, 358-381.