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Government Transfers and Inequality: An Anatomy of Political Failure

PFM, Vol. 8 No. 2, (2008)

Governments have long justified transfer payments in the name of reducing income inequality. The justification seems plausible and compassionate, if one takes an idealistic view of public and private incentives. Political authorities can simply take money from the wealthy with a progressive tax structure and use much of it to make net transfers to the poor, who would otherwise lead impoverished lives. Initially, this may actually seem to reduce income inequality and increase the incomes of the poor. However, political transfers soon begin motivating public and private responses that offset any equalizing effect the transfers may have upon income, and increase economic inefficiency. The long-run effects of the transfers are invariably no reduction in income inequality, fewer of the poor moving up the income ladder, and a national income smaller than it would otherwise be. This leaves the poor worse off than if the transfers had never been initiated, since they end up with about the same share of a smaller total income. Unfortunately, the poor have become both dependent upon, and victims of, the transfers, which makes it politically difficult for short-sighted politicians to improve the plight of the poor in the long run by eliminating the transfers.

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