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How Politics Makes the Market, Altering the Gap Between Rich and Poor

02/04/2011 01:22 pm ET | Updated May 25, 2011

In America, the top 1% has around 20% of aggregate income. This is income concentration on a scale not seen since the 1930s. Some have suggested the current reality is a reprise of the late-1800s "Gilded Age," a time in which society was dominated by a group of the super-rich with names like Vanderbilt, Carnegie, and Rockefeller.

Is this a problem? Liberals unequivocally say yes. While a few on the right are willing to provide a full-throated defense of inequality, even many conservatives say they are troubled by the current situation. So there's fairly broad agreement that we have too much inequality in America. But what can be done about it? Do the choices we make at the polls have any impact on the income gap?

Something can be done, and politics matters. Here is the simple story: Democrats equal more equality, Republicans equal more inequality. We might expect this to be the case because they disagree about redistributional programs like food stamps and welfare. But this isn't the explanation. The partisan difference emerges mostly because Democrats regulate the market and engage in "human capital formation" like education and health care in ways that give more people a better chance at competing in a relatively free market system, while Republicans do not. Let's elaborate a bit.

One of the favorite arguments from the right is that inequality is really awful, but it's out of our hands. George W. Bush's treasury secretary, Henry Paulson, said it this way: "market forces work to provide the greatest rewards to those with the needed skills... This... is simply an economic reality, and it is neither fair nor useful to blame any political party." What he's saying here is that inequality is largely out of our hands, the product of economic forces that are outside the reach of politics and policy.

Fair enough. The market is always going to produce inequality, probably more inequality than we would really like. The obvious response is redistribution. We create a progressive tax structure that funds benefit programs that redistribute income from the top toward the bottom: food stamps, Medicare, Social Security, school lunches, welfare, and so on. Since Democrats are pro-redistribution and Republicans are not, we can elect Democrats if we want more of it and Republicans when we want less. That's how we can influence inequality. And, by the way, it has quite a bit to do with political parties. Simple, right?

Not really. Redistribution may well be the most straightforward way for government to shrink the income gap. But the reality of American politics is that redistribution is, for the most part, a dirty word. One of the reasons Social Security and Medicare are so popular is precisely because we don't think of them as redistribution. In fact, it turns out that neither party in contemporary America is all that "pro-redistribution." It's true the Democrats put the New Deal and the Great Society in place, both loaded with a variety of redistributional programs. But when members of the 106th House were presented with the following statement: "It is inappropriate for government to implement programs that redistribute income from the rich to the poor," members of neither party were apt to agree. Democrats were more supportive of redistribution than Republicans, but members of both parties were on the anti-redistribution side of the scale.

More importantly, if we examine the redistributive impact of government -- the reduction in inequality due to taxes and transfer spending -- there is only slightly more of it when Democrats gain power in Washington and only slightly less when Republicans are in charge. In fact, some of my research shows that Democratic policymakers may actually generate less redistribution than their Republican counterparts. When push comes to shove, the existing American welfare state has broad political support. Who wants to cut Medicare or Social Security? It can happen, but nobody wants to do it, on the right or the left. And the fact is, these two programs are essentially the heart of redistribution. Every other redistributive program, from the tax system to welfare, is very much at the periphery.

So from here we could start ranting about how the parties are the same and choices at the ballot box don't make any difference for real people. Not so fast. Let's revisit the claim that the market essentially gives us a fixed amount of inequality that we are powerless to change. This just isn't true.

Government intervention shapes market outcomes all the time. It's something I call market conditioning. Quick example: Imagine a world without public primary and secondary education. Today's workers would be very different. Some would have the same skills they have in the current reality, most likely those whose parents had the means to provide them access to private education. But most would be less-skilled in our hypothetical world without public education. The market would certainly give us a different distributional outcome in this alternative world, and it would probably be more unequal than the one we live in (though it doesn't really matter for general the point I'm making here). Similar stories can be told about health care, workplace regulation, minimum wages, monetary policy, job training, securities regulations, and environmental protection. This list could go on and on, but the point is that to understand government's effect on income inequality, we have to look beyond traditional welfare and social insurance programs. Government shapes the economy itself.

In fact, government market conditioning influences the income gap in significant ways. And we can show that election outcomes influence inequality via the market conditioning mechanism by analyzing market inequality (for those more technically inclined in pre-tax and pre-transfer income inequality). This is the income gap that exists before we account for the effects of redistributive programs like taxes and welfare benefits. Accounting for a multitude of other factors, market inequality is lower under Democratic presidents and when liberal policies are enacted than under Republicans and conservative policies (see two recent books, my Politics of Income Inequality and Hacker and Pierson's Winner Take All Politics for more detailed analysis of this issue). Since partisanship and the ideological content of policy have an effect on distributional outcomes measured prior to the effects of taxes and transfers, we can conclude that government affects inequality by changing market outcomes.

Here is the bottom line: Who we elect matters. Democrats and Republicans produce different levels of inequality. Republicans produce more, primarily because they are not as willing as Democrats to intervene in the market to help level the playing field for all participants in America's capitalist economy. This suggests that those interested in how public policy affects income inequality in America should focus on market conditioning through health care, education, labor regulation, and financial reform as much or more than they focus on explicit redistribution through programs like Social Security and welfare.

Expanding access to health care can raise the productivity of those currently without insurance, likely reducing income inequality generated in the market. It's pretty clear that repealing the reform would reduce access, thus undoing any progressive market conditioning effects. Labor regulation is another issue to watch. New efforts to limit the bargaining rights and organizing ability of public employees are underway. These efforts, if successful, would lead to more inequality because unions protect employment, and employment produces equality.

Lots of factors shape inequality (see here for a nice summary), and partisan politics is certainly not the only determinant. But is it true that we are completely at the mercy of impersonal economic forces when it comes to inequality in America? No way.