Tax policy might level the odds and pay dividends across the whole population, rich and poor.
“Previous studies of how to set optimal taxes have typically ignored a crucial channel – the effects that parents have on their kids,” says Alexander Gelber, a professor of business economics and public policy at Wharton. He and co-author Matthew Weinzierl, a professor at Harvard Business School, mined new data and existing research for signs that taxes and ability are, in fact, linked.
Income linked to scores
Their paper, “Equalizing Outcomes vs Equalizing Opportunities: Optimal Taxation When Children’s Abilities Depend on Parents’ Resources,” marshals statistical evidence that supports the idea that increased financial resources for parents with low incomes can lift the performance levels of their children on standardized tests of cognitive ability.
The dominant model of optimal taxation is incomplete, the co-authors write. It treats the distribution of ability as unconnected – or “exogenous,” as the authors say – to optimal tax strategy. Their paper explores the consequences of relaxing current assumptions, assuming instead that tax policy and the abilities of children are connected – or “endogenous.”
The core conceptual contribution of the paper, the researchers note, is that it takes into account the dynamic interaction between exogenous and endogenous causes of skill differences.
The researchers used data on 3,714 children and 2,108 mothers between 1988 and 2000. According to the model developed by the researchers, a resulting tax adjustment would affect children of all taxpayers, but not in equal measure. “Giving parents resources has a bigger effect on children among the low-income parents than among the high-income parents,” says Gelber.
Think of it this way, Gelber states.
If the government were to distribute money randomly to some high-income parents and not others, overall results on upper-income kids would not change very much. In contrast, an identical distribution of cash to some low-income families would have much more pronounced effects on the cognitive abilities of their children, as intuition affirms.
Boosting earned income tax credits (EITC) would provide the means to confer extra cash on low-income families, the researchers propose. Each US$1,000 increase in disposable income for a given child should add two percentile points to that child’s ability levels as measured by national standardized tests.
Gelber adds a note of caution, however. While the researchers’ findings shed light on the need for an inquiry into existing tax policy, more research should precede concrete proposals.
Caveats include a concession that no existing data link how parents spend added income with variations in their kids’ outcomes. Nor do data exist yet to show the impact on income when children are old enough to join the work force. All else being equal, when this force is taken into account, it could justify lowering marginal tax burdens on the poor relative to the well off, the researchers argue.
Even in a theoretical realm, such findings might rub a raw political nerve. Restive voters favor lower taxes, not more transfer payments.
However, Gelber remains optimistic that changes could take place, even in the current climate. Over the past three decades, he notes, Republican and Democratic presidents alike have increased EITC payments that transfer money to lower- and middle-income families.
http://www.nber.org/papers/w18332.pdf