Protection and Redistribution
Property rights are an essential part of a market economy. Therefore, a vital government role is protecting those rights. If property rights are not clearly defined and defended, resources will not be allocated effectively. Property rights give people the right to use their possessions as they choose (within the limits of the law). This includes the right to exclude others from using a good or service, as well as the right to transfer the ownership or use of the resource to others.
If people aren't free to use their possessions as they choose, they might not be able to act in ways that create more efficiency and wealth. Without property rights, people would have less incentive to invest. People are willing to risk what they currently own because they expect to make a return on that investment.
One of the biggest investments many Americans make is buying a home. People are willing to make that investment because they think their property will go up in value and because they won't have to pay rent. If people were afraid that someone could easily steal their property away from them, they wouldn't invest in buying it. Despite the importance of property rights, sometimes the government infringes on them. As mentioned in the last lesson, urban planning usually involves designating that certain areas of land can only be used for certain purposes.
A contract is a legal agreement enforceable by law. If you buy a house from someone, you will both sign a contract. The seller can't take your money and then decide not to give you the house. You could very easily take them to court and get the property turned over to you. The court would enforce the contract that both you and the seller signed. If there was no guarantee that the government would enforce that contract, you would have much less confidence signing it. You might even think twice about agreeing to buy the house, afraid that the seller would back out of the deal and keep your money. Without the government enforcing contracts, people would be much less willing to trust contracts to buy, sell, or invest, which would reduce economic growth.
Government enforcement of weights and measures—government-enforced standards of measurement, such as weight, volume, or quantity—protects consumers when they buy products. When you pump gasoline into your car and the pump tells you that you've pumped ten gallons, you can trust that pump because it's been tested by the government.
Redistribution of Wealth
Growing economic inequality in the United States has become a major concern in the twenty-first century. In 2018, the richest 10% earned an average of $338,434, while the bottom 90% earned an average of $36,797. The percentage of the nation's income earned by the top 0.1% ranged between three to four percent from the 1940s through the 1970s, but it has been on a steady rise since 1980. The top 0.1% now earns about 11% of America's income.1
Why Governments Redistribute Wealth
This growing economic inequality has angered many American citizens, and the number of these dissatisfied individuals seems to be growing. The Occupy Wall Street movement in 2011 was a notable example of individuals protesting economic inequality. The protesters felt that the wealthiest members of society, often referred to as "the 1%," received too much income relative to the rest of the country.
This vilification of the wealthy has continued to intensify. Many voters are flocking to politicians who promise to increase taxes on the wealthy and make them pay their "fair share." For instance, one of Elizabeth Warren's big proposals during the 2020 Democratic Primary was to enact a wealth tax on "ultra-millionaires."
Thus, one major reason governments redistribute income is to satisfy individuals and groups who aren't satisfied with the current distribution of income in the economy.
Another reason that governments redistribute income is to create a safety net and help impoverished citizens who are in need. Unemployment programs, food stamps, and public housing are examples of such programs.
How Governments Redistribute Wealth
There are two main ways that governments redistribute wealth. Sometimes, governments redistribute income directly. When the government sends out an unemployment check or provides public housing, they are giving direct monetary assistance to an individual. One notable social service program that redistributes income is SNAP, the Supplemental Nutrition Assistance Program. SNAP, formerly known as food stamps, provides needy families with additional funds to buy food.
The government can also redistribute income indirectly through progressive tax rates. Remember that a progressive tax is a tax in which people with higher incomes pay a higher tax rate. This means that those with lower incomes pay a lower percentage of their income in taxes. By increasing the tax burden on wealthier citizens and decreasing it on poorer citizens, the government indirectly redistributes wealth. The federal income tax and most state income taxes are progressive taxes, making income taxes one of the largest tools the American government uses to redistribute wealth.
Proportional and Regressive Taxes
In the lesson on taxation, we contrasted progressive tax rates with flat tax rates, where everyone pays the same tax rate regardless of income. People who earn more will pay more, but they'll pay the same percentage rate. Another name for a flat tax is a proportional tax. A few states have proportional income taxes. The Medicare payroll tax is also a proportional tax. Individuals must pay the full 1.45% tax on all their income, whether they make $20,000 or $2,000,000.
A regressive tax is the opposite of a progressive tax. A regressive tax is a tax in which people with lower incomes pay a higher tax rate. In other words, people with low incomes will pay a higher percentage of their income in taxes than people with high incomes. The sales tax is a regressive tax because people at lower incomes spend a larger percentage of their money on taxable items, whereas people with higher incomes spend a lower percentage of their money on taxable items. People with higher incomes will spend large percentages of that income on investing and saving. Since they're not buying anything with that money, they don't have to pay a sales tax on it.
As an example, let's say Dan makes $30,000 a year, and he spends $10,000 of that income on consumer goods. If the sales tax is 5%, then Dan will have paid $500 in sales tax. This works out to be 2% of his total income ($500 / $30,000 = 2%). Rachel makes $200,000 a year, and she spends $40,000 of that income on consumer goods. That means Rachel will have paid $2,000 in sales tax, but that $2,000 is only 1% of her total income ($2,000 / $200,000 = 1%). In actual dollars, Rachel paid four times the amount of sales tax as Dan ($2,000 > $500). But in terms of percentage, Dan paid more. His tax rate was twice as high as Rachel's (2% > 1%).
Social Security tax is also a regressive tax because there is a cap on the amount of Social Security tax that an individual has to pay. (Remember that Social Security is a payroll tax of 6.2% that both employees and employers have to pay.) As of 2020, individuals only have to pay Social Security tax on the first $137,700 they earn. Any income above $137,700 is exempt from Social Security tax. Therefore, individuals with extremely high incomes will pay a lower percentage of Social Security tax than individuals with low incomes.
Review of Key Terms
property rights: the legal rights of individuals to use their property as they choose
contract: a legal agreement enforceable by law
weights and measures: government-enforced standards of measurement, such as weight, volume, or quantity
proportional tax: a tax that applies the same tax rate regardless of income; also known as a flat tax
regressive tax: a tax in which people with lower incomes pay a higher tax rate
The number of people advocating for increased redistribution of wealth has been growing in recent years. They believe increasing economic inequality is a major concern that can be easily solved by increasing taxes on the wealthy. Unfortunately, the issue isn't that simple. Hazlitt explained in Chapter 5 of Economics in One Lesson that increasing taxes discourages production because it reduces the economic incentives for business success. When taxes are increased for high wage earners, it reduces the incentive for people to become high wage earners. The higher the taxes are raised, the lower the incentive becomes. Eventually, the economy will stagnate as fewer people put forth the effort to start new businesses and create more efficient methods of production.