Public Policy Affects Income Inequality
 

One potential interpretation of the evidence above is that, because rising inequality is substantially a consequence of the impersonal forces of supply and demand, public policy has no role to play in shaping the trajectory of inequality or its social impact. This conclusion is incorrect for two reasons.

First, there are multiple channels by which policy has contributed to the rise of U. S. inequality, many of which are not fully evident in the education earnings premium. These include the fall over several decades in the real value of the U.S. minimum wage (7); the declining prevalence and bargaining power of U.S. labor unions; mounting international competition that places particular pressure on the wages and employment of less educated workers; and sharp reductions in top federal marginal tax rates that have raised after-tax inequality and increased the incentive of highly paid workers to seek still higher compensation.

But let us assume for the sake of argument that the rise of income inequality is entirely a market phenomenon. Would this imply that there is no role for public policy? A moment’s reflection suggests otherwise. As the economist Arthur Goldberger once famously observed, the fact that near sightedness is substantially a genetic disorder has no bearing on whether doctors should prescribe eyeglasses (53). What is relevant is whether the benefits of addressing myopia exceed the costs. In the case of myopia, the availability of eyeglasses make this an easy call.

Although there is no “remedy” for inequality that is as swift or cheap as eyeglasses, prosperous democratic countries have numerous effective policy levers for shaping inequality’s trajectory and socioeconomic consequences. Policies that appear most effective over the long haul in raising prosperity and reducing inequality are those that cultivate the skills of successive generations:

As discussed in the companion paper by Piketty and Saez, there is also disagreement among economists about whether the rising share of household incomes accruing to the top few percentiles of households in numerous developed countries over the past several decades is also primarily a market phenomenon, or instead reflects changing social norms, growing corporate misgovernance, slackening regulatory oversight, or increasing political capture of the policymaking process by elites (3–6).

It would therefore be a vast overstatement to conclude that the rise of U.S. inequality is exclusively due to conventional market forces, or that public policy has not played a role


 

excellent preschool through high school education;broad access to postsecondary education; and good nutrition, good public health, and high quality home environments. Such policies address inequality from two directions: (i) enabling a larger fraction of adults to attain high productivity, rewarding jobs, and a reasonable standard of living; and (ii) raising the total supply of skills available to the economy, which in turn moderates the skill premium and reduces inequality (54).

Of course, building skills is a multi-generational process and thus has little impact on inequality in the short term. There are, however, numerous nearer-term levers that moderate inequality directly without imposing substantial economic costs:

 

applying progressive tax and transfer policies that fund public investments and foster opportunities for children of all socioeconomic backgrounds; applying well-crafted labor regulations that ensure safe and nonexploitive working conditions; providing wage subsidies such as the Earned Income Tax Credit that increase the payoff to employment for those with limited skills; setting modest but nonzero minimum wage rules; and offering numerous social insurance policies (health and disability insurance, flood insurance, disaster assistance, food assistance) that buffer misfortune for the unfortunate. Although it is outside the scope of this article to evaluate these policies, it is critical to underscore that policy and governance has played and should continue to play a central role in shaping inequality—even when a central cause of rising inequality is the changing supply and demand for skills.

See Causes of Income Inequality