The Effects on the Fiscal Cliff on the Inequality of Income Levels - Research Paper Example

? How the threat of an imminent fiscal cliff is directly related to income inequality The assignment will talk about the effects on the fiscal cliff on the inequality of income levels. Reduction in income inequality is one of the prime concerns of any government. Studies show that most of the fruits of development have been accrued by the top earners and the high middle class while the society on the lower tier of the income pyramid remained out of purview. Introduction The fiscal cliff of United States is now the topic of discussion mainly due to the harmful effects it can have on global economies if remains unchecked. The whole problem was triggered by the quarrel over tax cuts for the wealthiest 1% percentage of Americans. It can be argued that the prospects of the future global economy depends much on the debate circling to distribution of income or equality among all sections of the society. The republicans support the tax cuts on the argument of the role played by income in the development of incentives. They argue that the role of the government is not ecstatic in managing the money of the tax payers. They put the example of the CEO who may feel the disincentive on working harder if the government levies a tax of 10% more on his income. The Republicans states the money that is paid by the tax payers can be more efficiently invested in profitable investments instead of wasting the amount in the inefficient programs of the government. Research question How the threat of an imminent fiscal cliff is directly related to income inequality? Literature Review The law makers of the country are facing three unattractive options. They can keep the policy on hold till the beginning of next year. With the implementation of the policy the spending rates are anticipated to go down and therefore the economy will again be on the verge of inflation. Again the deficit of the current balance is anticipated to fall as well. They can opt for the middle course which would address the issues of the budget to a certain extent and will also have modest impact on the rate of growth. Two dimensions can be put forwarded regarding the inefficiency of the government. The spending in the public sector cannot be identified as waste because some of the expenditures roll out to the private sector as well. In some cases the roll is large enough. Moreover some profitable investments can only be done by the government. An individual cannot be held responsible for his resources and the same individual can be held responsible for the choices he makes. It is undoubted that the policy maker will opt for the programs that bring equalization in the society rather than increase the taxes for the wealthiest population. The term economic inequality is used to define the gap between the rich and the poor. The disparities in distribution of the economic assets among individuals or groups of population are regarded as economic inequality (World Bank, 2005, p. 27-28). There are many causes for economic inequality and primary of them being the differences in wages and salaries of the employed. Inequality in the labor market leads to concentration of wealth in the hands of the few. Some of the other causes are racial inequality, gender inequality, tax loopholes and increasing costs of education. The distributive inefficiency gets reduced by economic inequality. Inequality acts to reduce the total personal utility. The simplest form of measuring inequality arranges the entire population from poorest to the richest and pictures the percentage of spending attributable to either quintile or decile of the arrangement. One of the most popular measures on inequality is Gini coefficient (Cullis and Koppen, 2007, p. 2-3). It ranges from 0 showing perfect equality to 1 showing perfect inequality. It is derived from the Lorenz curve which also arranges the population from the poorest to the richest. The Lorenz curve is drawn using the cumulative proportion of the population and the cumulative expenditure on the horizontal and the vertical axis respectively. The Gini Coefficient cannot be easily decomposed to find the sources of inequality. The report of the Centre on budget and policy priorities stated stagnation of wages for the workers belonging to the lower part of the income pyramid can be cited to be the reason for increasing income gap. The earnings of the individuals belonging to higher income bracket have grown significantly. Over the last three decades the economy of the country has gone through high levels of unemployment, intense global competition from foreign competitors, and a lateral shift in job sector from manufacturing to services as well as technological advancements. The policies of the government failed to maintain the real value of the minimum wage and the failure of the policies to provide adequate support to the low wage earners contributed to the increasing inequality. The changes in the tax codes acted as the catalyst in raising inequality. Analysis and findings The threat of the impeding fiscal cliff aroused intense discussions on whether the citizens belonging to higher levels of income are paying the taxes fairly. The more important issue was that of income inequality. It was believed that charging the higher income earners effectively will reduce the income inequality in an economy. The “trickle down” hypothesis was supposed to be true but empirical evidences showed that the flaws of the hypothesis. The report of the Centre on Budget and Policy Priorities documents the ever rising gap between the rich and the poor. The entitled “Pulling Apart: A State-by-State Analysis of Income Trends” report stated that the before the business cycles of 2007, the earnings of the highest income earners rose substantially while the lower income earners witnessed modest growth in income. This acts as the evidence of rising inequality in the country. The aftermath of recession continued till 2009. This period witnessed declines in earnings for people belonging to all levels of income. The scarcity of employment opportunities led to loss of capital gains. After 2009, the earnings of the wealthiest class began to take the rising curve again while that of the lower income earners remained on the flattened curve. The report found that the average incomes of the bottom fifth percent of the households fell by 6% in the period of late 1990s to mid 2000s. The average income of the top fifth rose by 8.6% during the same period. The top 5% of the households experienced a growth rate of 14% in income. The major reason for the economic disparity that can be accounted for is the stagnancy of wages for the society belonging to middle and lower income levels. President Barrack Obama has recognized the problem and in the campaigns he explained the pledge to push the wealthy Americans with more taxes and will ask the next 1% to pay higher as well. The president looks to lower the taxes for everyone unlike other previous Presidents. If the strategy of the President is successful, the revenue will take the rising curve while the amount of debt will get lowered. This will also narrow down the gap in income in the society. In the later part of the 1990s the reformation processes offered some increase in the range of minimum wages for the people belonging to the middle and lower tier of income line. But the increase in minimum wage was not sufficient to cope up with the persistent low level of employment. In the recent decades the inequality between the high and the low income households have raised than it was during the periods of 1970s. The policies of deregulation as well as trade liberalization with absence of effective laws and weak safety net contributed to increase the level of inequality. The reformations in the structure of federal and state taxes accelerated the trend towards inequality in the labor market. The additional incomes in the forms of dividends and capital gains were accrued only to the high income earners (Curry, 2012). The additional income coupled with high income acted to be the catalyst in widening the gap between the rich and the poor. The income of the investors was boosted by the large increases in corporate profits as stated in the economic recovery after 2001 recession. The minimum wage was not sufficient to provide the minimum food requirements. The value fell well short of the required amount and therefore the states can play the part in increasing the level which is necessary for sustained growth of the economy. The unemployment insurance scheme can be improve so as to cover as many unemployed as possible under the shelter of the benefit. The system of taxes can be made more progressive which aims to narrow down inequalities. The state tax systems are regressive in nature as the states tend to focus on increasing income through imposing sales tax and user fees. There are some possible ways on how the states can make the system of taxes more progressive. The dependence on sales tax can be reduced. The tax credits should be subjected to the low income earners and can offset the effects of taxes for those who lack the ability to pay. With the dying down of recession the states are taking the path of cutting the tax rates. However the tax cuts benefitted the higher income earners and if this policy continues for some time the tax system will become even more regressive. Limitations There are some limitations to the research. The fiscal cliff has been identified here only with respect to United States. If the same policies of fiscal cliff can be applied to many other developed or developing countries then some more interesting results could have been on the pipeline. The assignment discusses the effects of fiscal cliff only on income inequality. There are some other inequalities in an economy where the concept of fiscal cliff may be inapplicable. Therefore it would be wrong to hold fiscal cliff as the only possible factor to increase the level of inequality. The assignment engages no empirical research which will provide the evidence of impact of fiscal cliff on income inequality. A more structured research would have been possible if data on income inequality after the imposition of fiscal cliff could have been analyzed. Conclusion Reduction in inequality is one of the concerns for the government of United States. It was thought that fiscal cliff would contribute to reduce the level of inequality. The money raised from tax will be used for the welfare of the society and in that fashion it will be beneficial to bring overall benefit to the society. Taxing the rich will leave less amount of disposable income on the hands of them. Therefore the demand for the products is expected to take the falling curve. Reduction in demand will reduce the price and the poor will be able to buy the products. But President Obama holds a different view (Goldfarb, 2012). He aims to reduce the tax burden for the society as a whole. Although there are too few options left for the policy makers to exploit but the impact of fiscal cliff are supposed to bring down the level of income inequality as viewed by the democrats. The republicans are uncertain about the role of the government and therefore they stated that the government lacks the capability to make efficient use of the generated money through taxes. So they oppose the regulation of fiscal cliff with the view of not to waste money. References Cullis, J. and Koppen, B. ( 2007). Applying the Gini Coefficient to Measure Inequality of Water Use in the Olifants River Water Management Area, South Africa. Retrieved From: http://www.iwmi.cgiar.org/publications/iwmi_research_reports/pdf/pub113/rr113.pdf. World Bank, (2005). Chapter 6. Inequality Measures. Retrieved From: http://siteresources.worldbank.org/PGLP/Resources/PMch6.pdf. Curry, G. (2012). Income inequality grows in U.S. Retrieved From: http://www.newpittsburghcourieronline.com/index.php?option=com_content&view=article&id=8759:income-inequality-grows-in-us&catid=40:opinion&Itemid=54. Goldfarb, Z. (2012). How fighting income inequality became Obama’s driving force. Retrieved From: http://www.washingtonpost.com/business/economy/how-fighting-income-inequality-became-obamas-driving-force/2012/11/23/ab375434-3256-11e2-9cfa-e41bac906cc9_story.html. Read More