Derek Bannister

Prakhar Misra
August 9, 2017
A Governments Role in Tackling Inequality

As economies thrive on the ability of the typical consumer to make purchases,

governments should work to combat economic inequality to ensure sustainable economic

growth. In fact, consumption makes up 70 percent of the U.S. gross domestic product. Increased

consumer spending leads to higher production numbers, even increasing wages and decreasing

levels of unemployment. Political movements focusing on wealth inequality have sprouted up

across the world in recent years. The Occupy movement in the United States brought concerns

of excessive power in concentrated hands as a result of condensed wealth distribution. The fact

of the matter is that governments should look to put money in the hands of those who are most

likely to spend it, while aiming not to discourage workers with astronomical income taxes. These

governments can even reduce the volatility of business cycles through the redistribution of

wealth.

If a government is interested is spurring economic growth in the form of consumption, it

should work to put money in the hands of people who are most likely to spend it. The economic

idea of marginal propensity to consume (MPC) refers to the proportion of additional pay that a

consumer spends on goods and services. If a consumers income were to increase by one dollar

and he or she spent 80 cents on goods and services, their MPC would equal 0.8. Economic

studies show that in the U.S. the MPC for low-income households is significantly higher than

that of the high-income households. In other words, if the same amount of money were given

to low-income households as high-income households, the low-income households would

spend much more of it. The high-income households would save most of the money as their
income is already enough to pay for their desires. It is quite clear that governments can spark

economic growth by focusing on the MPC of different households. There is, however, a point at

which tackling inequality becomes more of a hindrance than a help.

Governments must be careful not to discourage hard work through aggressive policies

against economic inequality. Economist Arthur Laffer developed a theory explaining that as

taxes increase from low levels, tax revenue will increase until reaching an ideal point, also

known as the efficient tax rate. The Laffer Curve illustrates that the ideal point is what the

government searches for because it represents the maximum tax revenue while people still

work hard. Beyond this ideal tax rate, an excessive tax rate can discourage workers from working

as hard as possible. The ideal tax rate maximizing tax revenue, allowing governments to

redistribute wealth and work to close income inequality gaps. In essence, simply increasing tax

rates will not necessarily increase tax revenue. Disincentives from high-end tax rates can

actually drive workers away from entrepreneurial endeavors. Workers may even decide to

substitute work for leisure, realizing how heavily their work income is taxed. Even more

seriously, workers could decide to move to another country with fairer tax rates or strategically

avoid taxes. There are certainly instances in which slowing down economic growth can help

avoid rapid creating economic bubbles that could crash the economy, but excessive tax rates can

be discouraging to labor force participants over time.

Governments can certainly do significant good when it comes to redistributing wealth

and sparking increases in consumption. Poor policies, like excessive tax rates, can actually drive

down tax revenue and have an inverse effect on the ability of the government to redistribute

wealth. Governments need to intervene in markets to ensure sustainable economic growth.

Government intervention can help support minimum volatility in the economy, thereby creating

market conditions in which the economy is able to thrive.