Nova workboard

a blog from young economists at Nova SBE

Economic Growth vs. Income Inequality

What is more important; the economic growth in a society or income inequality of the population? There is no correct answer to this, since it is a normative question. However, the question and the effects can still be investigated. Gerald W. Scully does this in the article “Optimal Taxation, Economic Growth and Income Inequality in the United States” posted in National Center for Policy Analysis, 2008.

In the study Scully investigates United States from the period 1960 to 1990. He uses an econometric model to analyse data on tax rates, GDP and income inequality to find a growth-maximizing tax rate. He finds that this is 19.3 % of GDP but that they in fact had a much higher tax rate in the time period. In the study he links the tax rate together with the GDP growth rate, which shows that the growth rate would more than double if the U.S had had a tax rate of 19.3 instead of the actual 30.7 in average.

Besides the link between the tax rate and the GDP growth rate he also links this with the inequality. He does this by using the measure of the Gini coefficient. From this he finds that a 1 %-point change in the growth rate will lead to a 0.00075 %-point change in the Gini coefficient.

Furthermore he examines another way of looking at the Gini coefficient – what a reduction in inequality would cost. This shows that a fall in the Gini coefficient (more equality) of 0.001 costs 1.33 % per year in the per capita economic growth.

The above-mentioned are the results derived from the model Scully chose for his study. The choice of the model is not a positive question since he chose to have specific assumption etc. to be able to derive the results. The results then indicate what effects taxation; economic growth and income inequality have on each other. From this it is up to the policy makers self to derive the policies they find the best/most fair dependent of their preferences.

Another observation Scully makes is that the relationship between income inequality and economic growth in fact is not that big. He finds that there are other factors that have a much greater effect on the inequality. Although this may be true, one could also argue that it may not be the economic growth causing the income inequality but that it in fact is the income inequality causing the economic growth. But this is a whole other question to be answered in another study.