How The Government Creates Inequality

I’ve been reflecting lately on the nature of inequality.  As conservatives, we believe that some level of inequality is good for society.  I submit that the current level of inequality is neither natural nor the fault of private sector actors.  The government created the present level of inequality by manipulating markets and excessively spending.

I can think of a number of ways the government distorts the income distribution (taxation not among them):

  1. Government spending and the trade deficit.  Government policies (especially government spending) drive trade deficits.  Trade deficits suppress wages for the lower and middle classes (there are two ways for the market to adjust: either savings must rise, or wages must fall, and in our Keynesian world, the government does everything it can to discourage savings).
  2. Monetary policy.  The Fed fights inflation by taxing manufacturing; when it raises interest rates, the dollar appreciates, imports become cheaper, and the tradeables sector shrinks.  Since low-skill high-paying jobs are concentrated in the tradeables sector, this increases inequality.   A different dynamic happens in recessions; the Fed lowers interest rates to bid up stock and housing prices, which encourages upper-middle-class and upper-class people to spend more; this bids up the cost of living, and also increases inequality.
  3. Crony capitalism.  This creates inequality between the politically well-connected and everyone else (as opposed to simple inequality between income classes).  Frannie Mae and General Motors represent very different forms of inequality, and both arise from crony capitalism.
  4. Consumption bubbles.  This is a superset of #1, #2, and #3.  The government’s tendency to blow up consumption bubbles is very bad for inequality, since it encourages government spending, trade deficits, and crony capitalism, all at the same time.

Given the structural problems represented by our bloated federal government, does anyone really believe that fighting the symptoms with redistributive taxation and scapegoating the private sector will solve anything?  Better to fix the underlying structural problems.  And while I tend to think the phrase “shrink the size and scope of government” has become a terrible partisan cliche, that does seem to be the inescapable conclusion.

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