Within an economic system will inequality always exist? It is a topic discussed by leading economists throughout the years and yet still today it exists and continues to grow worse. The automatic response most people have to the problem is taxing highly on the rich so their disposable income is closer to that of the poorer creating an even distribution of wealth. However, this might not be the go to option if we begin to look at philosophies, such as trickle-down economics and look at the work of Thomas Picketty who emphasised the target on capital (wealth) rather than income as a way of targeting inequality in his book “Capital in the Twenty-First Century”. It is clear more should be done with combating inequality if we begin to look real world scenarios. Out of all G7 nations the UK is the only nation to have a wider inequality gap this century as the richest 10% control 54.1% of Britain’s wealth. If we then look at a country such as India we see an even worse scenario with the rich top 10% accumulating 74% of India’s total wealth. With rising inequality being evidential are we able to justify an increase of income and inheritance taxes on the rich in an attempt to reduce inequality? Or perhaps focus on one tax more than the other?
There are two main types of inequality: wealth inequality and income inequality. Currently within the UK, income tax is a form of an ad valorem tax. Those earning less than £11,000 pay 0%, those earning between £11,000 to £43,000 pay 20% in income tax, those earning between £43,001to £150,000 pay 40% and those earning over £150,000 pay 45%. In comparison inheritance tax is a tax imposed on property and money acquired via gift or inheritance at which the threshold is £325,000. This means that if the property or money acquired is valued at over £325,000, 40% of the total value acquired is taxed. Wealth inequality arises due to the unequal distribution of assets among a population, whereas income inequality refers to extent at which income is distributed unevenly in a population. As a result, higher income taxes can be used to deal with income inequality and higher inheritance taxes can be used to deal with wealth inequality.
Firstly for dealing with tackling the problem of income inequality, it’s important to create an overview of tackling it before we can justify increased income taxes on the rich. One distinct way in which an inequality gap widens is unemployment. Those that are unemployed are heavily reliant on state benefits and in order to reduce the inequality gap; the government could employ supply side policies or increase the benefits that the unemployed receive. The government will be more inclined to go for the first option rather than the later, because as unemployment decreases productive potential of the economy increases leading to a more sustainable form of economic growth. Supply side policies are a form of government intervention used to increase the productive potential of an economy, for example changes in education and training (potentially allowing workers to become more efficient), decrease in unemployment benefits (providing an incentive for those that are unemployed to seek employment) and most suited in this situation: job creation schemes so that there are actually job opportunities available for the unemployed. This is because however much you incentivise the unemployed to work without jobs available unemployment will never fall. One of the flaws to supply-side policies is that they are incredibly expensive to implement for the government, therefore increased government revenue from these higher taxes seems like a perfect way in which the government can go forward with the idea without having to borrow money that they would have to pay back in the future funded by increases in potentially regressive taxes which can further increase inequality. Overall, this can result in disposable income rising for those less well of and falling for those that are better off, creating a more even distribution of income across a nation. As a result, it would surely aid to warrant the imposition of higher income taxes on the rich.
If we begin to look at less economically developed countries, the focus tends to be more on state provision; mainly free education as a way of developing skills and escaping the poverty trap. We just have to look at a country like India to begin to realise the scope of how inequality rises as a country goes through a development stage. This can be seen by the figure:
We begin to see the difference in literacy rates between rural and urban India with it being 71% in rural compared to 86% in urban. If we then take into account the gini index between rural and urban we can make a strong link between education and inequality rising. Gini index can be seen from the graph:
As well as the problems faced in rural areas, a strong case is also made by a report from “The Annual Status of Education Report” that there is a strong difference in government schools than in private based upon the level of education they receive. Government schools have “poorer academic achievement” than private. It almost creates a cycle for those that are rich to stay rich and those that are poor to stay poor. The “rich” of India are able to afford private schooling and develop skills needed for higher paying jobs. In comparison, those that cannot afford private schooling have no option but to send their children to state run schools setting themselves up for lower paying jobs. An increase in either tax on the rich could mean increase government revenues, which the government could then invest in improving government education for those particularly in rural areas, the ASER also stated the key difference was that private schools had based there teaching in English and state in their native tongue. Changes in education will take a long time to come into effect and perhaps even longer in order reduce inequality; however progress is at least made this way, especially for a country with such a spread of wealth and income distribution.
This brings the argument, are there forms of government intervention that perhaps can reducing income inequality without having to raise progressive income taxes? Simply we can look at the minimum wage scheme. It almost acts like a minimum price scheme and firms are legally obliged to pay workers above a certain price an hour. Currently in the UK the minimum wage stands at £7.20 an hour for those aged 25 and over. Minimum wage schemes help to stop the exploitation of workers and can increase the disposable income for the poor. As a result, the rich have their wages stay the same and as the poor’s income increases this means that income is more evenly distributed within the population. The benefit with this kind of scheme is that income and inheritance taxes do not need to have drastic changes. However problems still arise with the scheme and may still need tax rises for the scheme to work. There might be cases where the government may subsidise some firms so that they are able to run with increased cost of productions as they can’t afford to employ workers at minimum wage. As well as this, there are other problems that are associated with it, such as unemployment rising as the labour pool outstrips the demand for labour. As talked about beforehand this unemployment can then lead to inequality rising once again and an increase in the price of goods as firms pass on their costs of production to consumers. As a result, real wages fall despite people’s wages rising as a result of the national wage scheme.
Inheritance is a way in which wealth inequality is created within an economy. Wealthy residents within a nation are able to pass on their assets to their heirs and it almost creates an unfair disadvantage. Evidently, people will start off wealthier than others. It seems peculiar in a way that income taxes for the wealthy within the UK (45%), yet inheritance tax is set at 40% with the threshold at £325,000, therefore can even affect those in the middle income bracket. As a result, I think that higher inheritance taxes set at a higher threshold would be the way forward in dealing with wealth inequality and reducing inequality on the whole. For example, setting it at 75% at a threshold of £800,000 would unsure that only higher income groups are targeted and potentially higher government revenues could be spent on job schemes. Thomas Picketty argued that since 1980 capital (wealth) has been growing faster than the economy and when this occurs it widens the inequality gap as the inherited wealth grows. Picketty also states that capital will continue to grow faster than the economy and inequality continuing to widen. The only way in which this can be dealt with is through taxing inheritance so the wealthy don’t pull away from other nationals. He talked about a global wealth tax being the focal point of a way of solving inequality.
We also have to look at the fact, how much higher can we tax on these high income individuals? It’s important to keep a balance as taxing too highly on these high income individuals almost disincentives them and may seek to move elsewhere with lower taxes. If this occurs then it could have negative side-effects for government revenue which may not increase as individuals in the higher income bracket have moved elsewhere. There also comes the problem associated with tax evasion as these individuals may hold offshore bank accounts to avoid higher taxes. As a result, without the increased government revenue and even a fall in government revenue could mean long term problems. Government would have to borrow money for job schemes and subsidising firms for the national minimum wage scheme, which they would have to make back up in the future by potentially raising regressive taxes. This in turn creates the problem of rising inequality as lower income households are hit harder through regressive taxes than their higher income counterparts. We can also look at the work of an Italian economist by the name of Vilfredo Pareto came up with a principle known as the “Pareto 80/20 Principle” in which he stated 80% of the wealth of a nation is controlled by the top 20%. Pareto hypothesised this “80-20” rule whilst making observations of the distribution of wealth within his home nation of Italy. He discovered that 20% of the population owned 80% of all the land. This is almost a law of nature and the principle is applied to contexts throughout everyday life, for example 80% of a restaurant’s turnover comes from 20% of its menu. As a result, does this mean that even if we do raise these taxes on the rich will Pareto’s principle still be obeyed meaning inequality hasn’t been reduced as 20% of the population will continue to have roughly 80% of the wealth.
A further problem arises when we look at trickle-down economics. This theory states that when those that are on high incomes have an increase in salary, then everyone in the economy will benefit. Following an increase in income, these individuals increase their demand within the economy and consumption will increase, as a result this could mean that there are more employment opportunities for other individuals on lower incomes. However, if we increase both income taxes firstly, this means that these high income individuals will have less disposable income leading to their demand and consumption decreasing. This can then almost create the opposite effect of trickle-down, creating demand deficiency within the economy leading to unemployment increasing as firms attempt to cut their cost of production to retain similar profits as their sales will fall. In comparison, increasing inheritance taxes means that a similar effect is created to that of increasing income taxes. People assets are as a result are worth less and this creates a negative wealth effect. This will then lead to consumption within the economy falling and demand deficiency occurring. Similarly unemployment will increase, making the argument that increasing both income and inheritance taxes could potentially be negative for the economy as a whole with the government trying to achieve their macro objective of economic growth. Overall, this would mean that perhaps an increase in these taxes may not reduce inequality at all and potentially a nation could face real economic downfall from a lack of demand.
Overall, I think there is only so much the government can tax on income before economic problems arise within the economy. As a result, I think wealth should be the main focus for the government and this in turn should influence them in making changes in inheritance taxes rather than income. This doesn’t disincentives people to work hard as their incomes rise and are not taxed more heavily as a result of their hard work. I think the best option as a result would be increasing inheritance taxes with a higher threshold so it affects only the high income bracket for more developed countries, such as the UK. I think similar changes should be made for developing countries which in turn increased revenues can be spent on education or even employing a minimum wage scheme. This ensures that both wealth and income inequality fall. Overall, I believe that the focus should always lie with the wealth taxes so the rich don’t pull away from the rest of society. This supports the claims made by Picketty and if the political side is achieved, should be the path to go to in creating a world with reduced inequality.
Hello I am Rohan.