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VOL. 36 | NO. 49 | Friday, December 07, 2012

Fiscal equality vs. efficiency

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Beneath the “fiscal cliff” debate is a fundamental battle of philosophy. Liberal economics prioritizes equality, while conservative economics prioritizes efficiency. Migration toward either of these polls contains costs and benefits. Below is an excerpt from a tax study of developed nations commissioned by the Paris based OECD:

“In practical policy terms, a greater revenue shift could probably be achieved into consumption taxes. However, with consumption taxes being less progressive than personal income taxes, or even regressive, a shift in the tax structure from personal income to consumption taxes would reduce progressivity. Similarly, shifting from corporate to consumption taxation would increase share prices (by increasing the after-tax present value of the firm) and wealth inequality as well as increasing income inequality by lowering capital income taxation. Such tax shifts therefore imply a non-trivial trade-off between tax policies that enhance GDP per capita and equity, which is likely to be evaluated differently across OECD countries.”

So if economic sensitivity is highest with income, corporate and capital gains taxes, why are we willing to raise them? Because our values system perceives that the disparity between the rich and the poor has grown too large. At the moment, the country is willing to trade more equality for less efficiency. As the OECD recognizes, each country must make its own value judgment between the two choices, which can be measured. Each year, the World Bank calculates its GINI coefficient index. The index measures income disparities within each country. A GINI of 0 means perfect income equality. A GINI of 100 means perfect income inequality. The United States has a pre-tax GINI coefficient of 48.6, roughly in line with France.

However, after-tax the US GINI coefficient drops to 37.8 while France drops to 29.3. Redistributive tax policies account for these adjustments. Clearly within the tax code France prioritizes equality more than the U.S.

However, as the OECD warns, there are tradeoffs. Today per capita GDP in the U.S. amounts to $48,000 compared with $35,000 in France. The tax policy of the U.S., directed by the values of our nation, has largely favored economic growth over income equality. By engaging in a national debate over the structure of tax policy and spending, we are readdressing our values structure. A resolution to the fiscal cliff through higher taxes on the wealthy and more spending on the poor should lower our after-tax GINI coefficient, but likely our economic growth rate as well.

Less Uncertainty Means Higher Returns

U.S. politics may be rattling investors, but overseas things have calmed considerably. The once forsaken euro has stabilized around $1.30 and Chinese economic statistics have accelerated. Looking back over the trailing three months, the U.S. Stock market has gained 1 percent, while Asia and Europe’s markets have gained 6 and 9 percent respectively. Removal of political uncertainty has been very beneficial to Asian and European stock markets. Odds are it will be beneficial to ours as well, no matter what the fiscal cliff prevention policies turn out to be.

David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Waddell & Associates, with offices in Nashville and Memphis.

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