Alan Auerbach: On Inequality

The UC Berkeley Heavyweight Discusses Taxation, Morality, And The Future Of American Inequality.

On Monday, May 9, 2016, On The Ideal State Founder and Editor-in-Chief Samuel Oshay interviewed Dr. Alan J. Auerbach, the Robert D. Burch Professor of Economics and Law at the University of California, Berkeley, at his university office. He currently serves as the Director of the Robert D. Burch Center for Tax Policy and Public Finance. You can learn more about Professor Auerbach, here.


On The Ideal State: I first met you at a debate between yourself and Dr. Yaron Brook, the Executive Director of the Ayn Rand Institute, who I also interviewed for this site. The topic of the debate was economic inequality, and he took the side that the American focus on inequality is completely misplaced. You took the other side. So I begin with the simple question: is it a legitimate and desirable use of government to intervene and redistribute wealth?


Auerbach: I think so. I would not limit it to discussion of wealth; I think redistribution of resources more generally, perhaps including wealth, is an appropriate initiative of government.


On The Ideal State: Why is that? Does it do harm, the economic inequality that we see?

Auerbach: Frankly, I think you can give two justifications for it. One is the simple political justification that in order for a society to function, people have to be willing to participate. In a society where a lot of people feel that they are left out and that it is unfair to them, they may not take part in the daily functions of an economy that we really need for the economy to work. I also think there is an ethical question to the extent that there are very unequal outcomes, and not just economic outcomes, but health outcomes and other things that are related to that. One might be concerned about the extent of inequality, particularly if it has gotten worse over time, as it has in the United States.


On The Ideal State: Is it truly a question of inequality? Or is it a question of poverty?


Auerbach: Well, those are related, but distinct, questions. Different people have different views about the extent to which we should care about inequality per se, as opposed to caring about poverty. I think both issues are relevant. If you think particularly about the political issue, a lot of the people who are very angry in this election cycle are not people who are in poverty, but people who feel that they have not gotten a very good deal from society. Maybe their expectations were higher than their outcomes. Maybe there has been a change in circumstances that has made them unhappy. And these are people who anti-poverty programs would not necessarily help, because they are not in poverty.


On The Ideal State: Is that your theory for the rise of Donald Trump?


Auerbach: I think it has a lot to do with the rise of Donald Trump. I think it has a lot to do with the success of Bernie Sanders. People tend to think of them as being on opposite ends of the political spectrum, but I think they both appeal to people who are unhappy about recent economic events.


On The Ideal State: So you mention Bernie Sanders. His platform is essentially that we should tax the rich to fund more public goods. And invariably, he points to Norway, Denmark, Sweden, and the Scandinavian region as a whole as an example of the feasibility and the desirability of such a plan. So as the director of a center on tax policy, how does Scandinavia pay for it all? What taxes do they have that we do not, other than a higher marginal income tax?


Auerbach: Well, it depends on the country. First of all, you probably want to leave Norway out of the discussion, because Norway has enormous energy resources that it uses to pay for a lot of its programs, and the energy resources are largely at the command of the government. So let us leave Norway to the side, and look at a country like Denmark. Denmark does have a larger government sector than the United States, and it does have higher taxes. But it also has a different economic and social setting than the United States. It has much more underlying equality than the United States does, and it is a much more homogenous country than the United States in terms of its social groups. So it does not face the same kind of challenges as the United States does in thinking about how to address inequality. And it also has a different political situation. For example, the United States has been struggling with its budget for the last several years and has had a lot of political division. There are much, much larger issues here than in a country like Denmark, where, even though there are different political parties, there is much more of a consensus in terms of what policy should be.


On The Ideal State: What would be the ideal actions for government to take to remedy inequality, then?


Auerbach: Well, it is certainly better to deal with economic inequality in a way that utilizes the forces of competitive markets, rather than trying to keep those forces from working. For example, I think that policies that encourage people to become more skilled and educated, so that they can be more productive workers, are more desirable than policies that transfer resources to people who have lower skills. On the other hand, there are going to be limits to the extent to which we can get market outcomes to be fairer simply by skill accumulation. People are naturally going to have different abilities given the current rewards of the market, and we cannot expect people simply by working harder to overcome the great degree of inequality that exists.


On The Ideal State: One concern that I have for a big Bernie-style government imposing a bevy of taxes and regulations is an increased opportunity for lobbying and rent-seeking. Is this misplaced at all?


Auerbach: No, I agree with you, and I think many of his proposals are very unrealistic. I think they would cost more than we really have an ability to pay. I agree that large government bureaucracies, even if they are aimed at achieving beneficial social outcomes, pose a danger in themselves--which is not to say that I am against having bureaucracy. But I think that one has to take account of the fact that having government make decisions, rather than private individuals, involves costs.


On The Ideal State: So you have mentioned twice now the United States’ ability to pay and our fiscal gap. How do you see the role of the growing national debt play out in the future? Is there an optimal way to shrink it?


Auerbach: Well, there are ways of shrinking it that would either have more or less economic damage, and there are also issues of who will bear the burden: what generations and what income groups. I think it is a real political challenge for the United States to deal with this fiscal gap. It has been getting worse. We had some periods, perhaps in the 1990’s, when it would have been easier to deal with, yet we now have very, very large commitments for old age entitlement programs that are going to be difficult to meet. We should be dealing with it very soon, even if it is a solution that takes place over time. But it would require political actors with a very long horizon, who are concerned about not just the next month or the next year, but the future and future generations. And thus far, many politicians have paid lip service to these issues, but not very many of them have actually acted to do anything about it.


On The Ideal State: Earlier you mentioned market competition as a solution to inequality and the national debt. Does it make sense to use taxation to create artificial incentives for people to donate to charity in hopes that increased revenue to private charities--that are, in a way, competitive--will be able to fund some of the public goods that government currently ineffectually provides?


Auerbach: Well, we rely quite heavily on charities. The United States is really an outlier in the extent to which we rely on private charities to provide social services. Charitable contributions in the United States are many times larger, as a share of GDP, than they are in any other country. I think that relates both to the tax incentives people have to donate to charity and also that people in the United States have a much more positive attitude toward such donations. I certainly think that charitable institutions have an important role in many sectors--poverty alleviation and also addressing certain other social concerns--but I do not think that these organization can do everything that we rely on the government to do. I just do not think it is a big enough sector or could be.


On The Ideal State: Is there a way to grow the sector?


Auerbach: Well, I think it is pretty large. In the same way that we might worry about large government bureaucracies, giving individuals very, very large tax incentives to donate to charity involves essentially directing government money to uses that private individuals decide on. While many of the donations are quite altruistic and selfless and really aimed at trying to accomplish very good things, not every charity is all that productive in terms of accomplishing social ends. So I think one would not want to push this one too far.


On The Ideal State: I think we both advocate for the incentivization of morality through write-offs for charity, but is it a legitimate use of taxation to incentivize morality or disincentivize immorality, such as in a soda tax, a tobacco tax, or a gaming tax?


Auerbach: Well, there are strengths and weaknesses to this approach, and one would not want to go too far. There are certainly concerns people have about the nanny state, about government telling everybody what to do and adjusting prices of everything to direct people in a way that the government thinks is right. It is paternalistic, and we worry that maybe some particular government may have funny views that are not shared more generally by society. On the other hand, in cases where there is pretty clear evidence that a certain behavior is not good, having government tilt the scales either against it, in that case, or in favor of it, in other cases, does not strike me as very pernicious. I do not see any problem with government encouraging people to get vaccinated against deadly diseases. I do not see a problem with government discouraging people from being heavy smokers. These are cases where the evidence is pretty clear about the costs and benefits, and I do not think there would be huge, violent disagreements about that.


On The Ideal State: So if we could tie our discussion of incentives with our discussion earlier about public goods and higher taxes, is there a political incentive for the rich to support higher taxes and more public goods? And if there is not, what would be one that we could create?


Auerbach: I think there are some wealthy people who recognize that it is not really in their interest to live in a chaotic or unstable society. I do not think that they want to live in a South American country, where they need body guards; there, they will get to lobby politicians, but on the other hand, they will have to keep their money in another country for fear of expropriation. It is in the interests of the wealthy, as well as everybody else, to have a country with a stable, democratic political process. And I think many of the wealthy understand that in order to preserve many of the wonderful things about the United States--where a wealthy person can be admired and respected and walk down the street safely without a body guard--they need to have a system in which most people feel that it is fair and that they have got a shot and that they are willing to participate in.


On The Ideal State: On the topic of South American billionaires and millionaires having their money offshore, do you have any opinions on the Panama Papers?


Auerbach: Well, many of the people exposed in the Panama Papers were not American. While these are problems that exist in the United States, they are probably more severe in other countries. The United States has its own problems with people keeping money offshore to evade taxes. Obviously, to the extent that we have a tax system that tries to tax United States residents, there are going to be some people who behave aggressively and, in many cases, illegally to try to hide their money from taxation. It is difficult to tax wealth. People who have a lot of wealth have a lot of ways of avoiding taxes legally or evading taxes illegally, which suggests that not only are there limits to the extent to which we can tax the very wealthy, but also that we have to think about the ways in which we do it: that some taxes are going to be easier than others to administer, et cetera.


On The Ideal State: How would we make it more difficult for the rich to avoid taxes? A simpler tax plan?


Auerbach: Yes, I think simpler taxes. Perhaps taxing people based on their purchases, rather than trying to measure their wealth. Ultimately, there is no perfect way of doing it. If individuals keep money offshore in secret bank accounts, no matter how we try to tax them, we may not succeed in doing so.


On The Ideal State: So what are the differences between an income tax and a consumption tax. What is the divide and what are the virtues and vices of each?


Auerbach: Well, the divisions are not that great, and they are sometimes overemphasized. Basically, an income tax taxes income as it is earned, and the consumption tax taxes expenditures that people make, to the extent that people will eventually spend their income. You are taxing them either way whether it is on income versus consumption. Some of the differences have to do with timing, other differences have to do with the extent to which you are taxing the earnings on investment and saving--which income taxes do, and consumption taxes do not. Because of that, it is sometimes argued that consumption taxes are not as progressive, because there is a lot of wealth among high income people. But to the extent that high income people spend their wealth, consumption taxes can be quite progressive, and indeed, have sometimes been proposed by proponents of redistribution as a more effective way of accomplishing redistribution.


On The Ideal State: On the topic of the progressivity of American tax rates, Bernie Sanders advocates for higher marginal taxes on the rich, up to 90%. And then he points to Denmark and Sweden. But if you look at Denmark and Sweden, the rates of progressivity are quite low; they are 1.2 and 1.5, compared to the United States at 8.5. What do you think about that?


Auerbach: I think it is often misunderstood how progressivity is accomplished in the countries like the ones you mentioned. The way progressivity is accomplished there is not so much through the tax system, but through much more generous social programs. We have very large social spending programs in the United States, but to a great extent, they are old age based programs: Medicare, Social Security, and to a large extent, Medicaid, as well. Those are all programs targeted at the elderly, and not just at the poor elderly, but at the elderly in general, whereas in Europe, there are a lot more social spending programs aimed at families and the poor and so forth. In fact, one of the arguments that people in Europe who are in favor of redistribution make for having taxes like a value added tax, which is not progressive, is that one should not look at the tax system alone to think about progressivity, instead at everything the government does. I think a fixation on higher marginal tax rates is both reflective of a lack of understanding of how progressivity is achieved and reflective of a lack of understanding of the damage that very high marginal tax rates can produce.


On The Ideal State: Earlier in the interview, you hinted that there are kinds of inequality that are not economic, such as familial status and other intergenerational factors that make it more difficult for people to succeed in life. Most people in life would argue that educational opportunities would suffice as a remedy for such inequalities. Is education a sure fix?


Auerbach: Education is part of the solution, I think, but it also depends on when you are talking about it. For example, giving people better access to higher education misses a lot of the problem, because many of the problems in terms of background start really early in life. And if you want to improve the economic outcomes of people who are not doing very well, you need to start a lot earlier than college. Taking a child who has had a terrible family background and a terrible elementary and secondary education and saying “We’re going to give you better access to college” is not very helpful. We need to start at much earlier ages, and that involves interventions that are going to be quite intrusive. So it is not exactly clear how to do it, and the extent to which it would be acceptable to society.


On The Ideal State: Do you think the government monopoly on education sufficiently provides educational opportunities?


Auerbach: No, I think charter school initiatives--which are growing around the country--are not always helpful, but certainly have indications that those kinds of reforms can help in a couple of ways. One is by providing better opportunities than the existing, traditional public sector. And they also help by increasing competition, which can put more pressure on the traditional public sector to reform its own delivery of education. There is evidence that charter schools are particularly helpful in cases of urban environments, where the public school options may be very unattractive. So school reform, including not only charter schools but also reform of traditional public schools, can be very important.


On The Ideal State: So beyond economic and educational inequalities, are there any other major categories?


Auerbach: Well health has gotten a lot of attention in the past year, and deservedly so. There have been increasing gaps between the upper part of the income distribution and the rest of the income distribution in terms of life expectancy, which is somewhat surprising, given that there has not been any major disease outbreaks or anything like that that might have damaged the life expectancy. We are seeing it in terms of alcoholism, opiate use, and so forth. These may be the most direct causes, with suicide, of increased mortality, but there is obviously something going on beneath the surface that is leading to this kind of behavior. And whether it has to do with diminished economic outcomes or a less stable family life or some other problem--it is hard to know--but it is certainly something that deserves attention.


On The Ideal State: Do you think government can take any steps to address those health problems?


Auerbach: Well, it can certainly take very directed steps at educating doctors on the prescription of opiates and so forth, but I think we need to come to a better understanding of what is leading to this kind of self-destructive behavior. You cannot simply outlaw self-destructive behavior; you have to understand why it is happening.


On The Ideal State: To wrap it up, one final question: how do you see these issues of inequality in the long run, one hundred years down the road?


Auerbach: That is a very good question, but it would also take an extreme lack of humility to make any forecast that far into the future. When I was studying economics, one of the things that I was told with almost certainty was that nothing much was going on in the income distribution. It was quite stable. It had been very unequal around 1900, and it had become more equal over the course of the twentieth century. Then, during the post-war period, for decades, nothing much had happened. And if one wanted to make projections then, they would have said, “This is not going to be a very interesting topic of discussion.” Obviously, it has become a lot more interesting in the last few decades. Whether that continues, whether that reverses…. It could reverse. One of the things that market economies do is give people strong incentives. And there are a lot of people now who are getting very strong signals that they need to become more educated and get higher skills in order to compete in the global economy. And the extent to which they react to that, we may have, even without government intervention, a reversal of the problem of inequality that we have now.


On The Ideal State: Thank you so much for being here.


Auerbach: My pleasure.