How can we reduce wealth inequality?

We next consider some generalizations of the model to see what can be done to reduce the excessive wealth inequality that occurs. One possible way of avoiding wealth accumulation is to not allow agents to lose a part of their wealth on most economic exchanges. If every good was priced exactly at its value and if every worker received in wages the added value of the products they produced, everybody’s wealth would remain constant. However, this scenario is not realistic and not even desirable because profits can be used to grow the economy for the benefit of all. Instead, we need to look for other mechanisms that might lead to greater wealth equality.

One mechanism that might result in reducing wealth inequality is taxation. We will introduce three types of taxes in the model. One type taxes the amount gained in a transaction. This tax is similar to a sales tax or more accurately a tax on the profit made by one agent in each transaction. For simplicity, we will refer to this tax as a sales tax because this terminology is more familiar. Another approach is to tax the change in wealth over some interval of time; such a tax is similar to an income tax. Or we can tax the amount of wealth itself. The closest tax of this kind is a property tax. In addition to the different types of taxes, there may be different tax rates, depending on the amount of wealth or income. The rate for sales taxes usually is the same for all exchanges, except for food and clothing which are excluded in some states.

The following simulations that we discuss incorporate the effects of a flat sales tax for which the tax rate is the same regardless of the amount of the exchange, and progressive income and wealth taxes for which the tax rate increases with income and wealth. For simplicity, we set the income tax rate at 30% for income over $50,000, 20% for income between $20,000 and $50,000, and 10% for income between $10,000 and $20,000. These rates are roughly comparable to the income tax rate in the United States. The wealth tax rate in the model is 3% for wealth over $500,000, 2% for wealth between $200,000 and $500,000, and 1% for wealth between $100,000 and $200,000. For simplicity, we choose the sales tax rate to be 10%.

The way we tax is only half of the story. The other half is what we do with the revenue from taxes.

Politicians and the media constantly debate the former, but seldom do they discuss how tax revenue is distributed. Part of tax revenue goes to running governments, such as salaries for government officials, costs to build and maintain government offices, and the military. Another large part is for subsidies of various economic interests such as agribusiness, oil companies, and transportation. Some tax revenue is used to fund social programs, but it is not common for tax revenue to specifically address wealth inequality.

We will introduce two ways of distributing tax revenue; reality is somewhere in between these two limiting ways. One way is to distribute the tax revenue so that the wealth of the agents is increased by the same percentage of their existing wealth. We will refer to this method of distribution as proportional revenue distribution, because wealthier agents receive more of the tax revenue than poorer agents. Another way is to give each agent an equal amount, regardless of the agents wealth. We will call this way equal revenue distribution. Equal tax revenue distribution is rarely done directly, but instead is in the form of social services such as free or inexpensive health care, education, child support, and a safety net for those who are disabled or unemployed.

The model collects the sales tax after every exchange, and income and wealth taxes after every N transactions. Tax revenue is distributed after N transactions. For simplicity, we start all agents with the same amount of wealth. Before you do the simulations, which taxation mechanism and revenue distribution do you think most benefits the poorer agents?

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