Automation and inequality with taxes and transfers

Technical change in key OECD countries since 1990 is examined in terms of its contributions to total factor productivity and to factor bias. The dependence of real income and inequality on changes in factor abundance, total factor productivity, factor bias, the relative cost of capital goods and the progressivity of the tax system are quantified using an elemental general equilibrium model with three households. For the US, changes in factor bias are shown to have been responsible to the great majority of the observed increase in inequality between 1990 and 2008. The widely anticipated further twist away from low-skill labour is then examined, with downward rigidity of low-skill wages and transfers that sustain low-skill welfare, the increments to which are financed either from capital income or consumption taxes. The potential is identified for unemployment, or “subsidised leisure”, to rise to extraordinarily high levels, with Pareto improving gains requiring that the technology twist accompanies substantial increases in total factor productivity.