Government Expansion Increases Wealth Inequality

Chris Edwards

Federal and state governments run many social programs that support lower and middle-income households. One cost of such programs is that they undermine the incentives and the means for households to accumulate savings. Effectively, they displace, or “crowd out,” private wealth-building, particularly for non-wealthy households.

As government programs for retirement, healthcare, and other needs have expanded, more private wealth has likely been displaced, and wealth inequality has grown. Leftists decry wealth inequality, but their efforts to expand government likely increases it. This point was made last week by Larry Summers at the Peterson Institute. Summers was likely influenced by Martin Feldstein’s pioneering studies that found Social Security substantially displaces private savings.

This displacement, or crowd-out effect, was explored in a 2016 study by Baris Kaymak and Markus Poschke. They built a macroeconomic model of the U.S. economy to untangle the causes of changing wealth inequality over recent decades. What they found is that the main factor raising U.S. wealth inequality has been increased wage dispersion generated by technological changes.

In addition to that effect, Kaymak and Poschke found that the expansion of Social Security and Medicare has further boosted wealth inequality:

By subsidizing income and healthcare expenditures for the elderly, these programs curb incentives to save for retirement, a major source of wealth accumulation over the life-cycle. Furthermore, since both programs are redistributive by design, they have a stronger effect on the savings of low- and middle-income groups. By contrast, those at the top of the income distribution have little to gain from these programs. We argue that the redistributive nature of transfer payments was instrumental in curbing wealth accumulation for income groups outside the top 10% and, consequently, amplified wealth concentration in the U.S.

The economists estimate that the expansion of Social Security and Medicare caused about one-quarter of the rise of the top one percent share of U.S. wealth in recent decades.

Social Security and Medicare spending increased from 3.5 percent of GDP in 1970 to 8.3 percent by 2018. Those are the two largest federal social programs, but other programs have likely added to displacement and wealth inequality effects as well.

In an upcoming Cato Institute study, Ryan Bourne and I explore these relationships. Ryan has also discussed this theme here and here, and I have here and here.