Economic Inequality: An Overview
The past year has not been a walk in the park: Lockdowns and restrictions continue to impact millions of people, the working demographic undergoes constant change, and the cost of survival becomes a significant concern for a substantial part of our population. With the added realisation that multiple jobs pay less than unemployment cheques, the debate of economic inequality is brought back under the spotlight.
Economic inequality is defined as the unequal distribution of income, assets, and opportunities among society’s different classes. Even with a decrease in people living below the poverty line, the rich continue to get richer, and the gap only widens.
Understanding Inequality
The rise in inequality can be attributed to numerous elements, such as-
- The cost of living continues to rise, but salaries remain more or less the same
- Geographic disparities and bureaucracy hamper the efforts of developing nations to progress
- Policies intended to keep wealth in check have not realized their purpose
- Gender bias and racial bias (among others)
Studies also show that economic inequality is a generational issue. The future generation’s wealth is in part determined by the amount of investment the previous generation has put in education.
Financial literacy is still considered a skill rather than a necessity.
The effects of inequality are a point of fierce contestation. Economic inequality has been widely correlated with high economic growth, with China and the US being prime examples. This relation is widely due to a higher incentive to enter upper society and a greater drive to innovate.
Economists have stated that inequality occurs in all market forms. Recognising that fact, they argue that it allows for implementing policies like a progressive tax, thus relieving financial stress from poor households.
On the downside, high inequality levels can also stifle economic growth: Physical capital becomes more scarce, and market volatility reaches unpredictable levels. The wealthy gain a disproportionate influence on a country’s political structure and tend to be behind severe ecological damage.
High inequality levels indicate that a notable portion of society is facing relative poverty, which burdens the economy by increased spending on job opportunities and social security programs.
The Great Gatsby Curve (made famous by Alan Krueger) serves to show that individuals have a harder time climbing the economic ladder in countries with higher levels of income inequality.
A study argues that governments don’t address inequality enough because the general population doesn’t know how big the gap exactly is.
-The New York Times, 2011 (Study by Michael Norton and Dan Ariely)
Redistribution of Wealth
So why don’t the rich donate all their excess cash? Some argue they have a moral obligation to do so (Limitarianism).
However, a few counter-arguments arise. The major part of wealth is in non-monetary forms such as investments and assets; liquidating these sources is no easy task.
The majority of the upper class consists of self-made millionaires/billionaires (another train of reason claims that such wealth is a collective effort and not just individual sacrifices). These people have been hoarding and trusting their instincts so far; a break in habit can not be expected overnight. Some always had the goal of making money and don’t see a reason to stop at their current point.
Another critical point is that the rich know the advantage of concentrated money sources over spread-out sources. They believe concentrating their wealth towards key issues is more helpful in the long run than spreading out cash over multiple fronts — The Bill and Melinda Gates Foundation is one such example. Furthermore, trust in the government’s capability to efficiently use the extra money is not a common sentiment amongst most people, rich or poor. Other reasons include inflation due to increased cash flow, inefficient structures to uplift the population, and corruption.
Redistribution has been a tricky topic since it involves taking away wealth from the rich without any equivalent exchange. A few proposed solutions to combat inequality are-
- Increase spending on key sectors (Education being a top priority)
- Setting up stronger regulations to combat influence from the affluent
- Raise minimum wages and ensure more equal salaries (Practiced in Japan)
- Improve the capital gains tax
- Raise awareness on different biases
- Introduce a global wealth tax
The Capital Gains Tax
Capital gain is the increase in the value of an asset over time. This gain can be seen in stocks, bonds, real estate, and other investments. Taxation on this profit (upon sale of assets) is known as the Capital Gains Tax.
Critics have pointed out that despite progressive taxation, the rich pay an unequal share of their wealth as tax. This is because progressive taxation is carried out based on income; most of the upper class make their wealth through investments rather than income. This leads to the rich paying a lower rate of taxation (rate based on their actual wealth) than the general population. This is where the Capital Gains Tax comes into play.
Since this tax is based on the profits made from assets, the rich receive no exemption from paying a consistent rate (Capital Gains Tax only applies for immense profits and not every single gain in stock price or asset value). However, it is clear that the tax still has trouble in controlling the usurping of wealth.
A few flaws of the tax are-
- The tax rate on capital gains is generally lower than the tax rate on wages.
- Taxes on accrued capital gains are forgiven if the asset holder dies (seen in a few countries) — the so-called “Angel of Death” loophole.
- Taxing capital gains on realisation (sale of assets) also drives tax sheltering (using assets to get loans with tax-deductible interest.)
Current taxation systems do not tax the overall wealth obtained by a household in a financial year. This means the rich avoid paying for gains incurred in a year if they continue to hold onto their assets (in addition to the low cost of income tax). This disparity is a major reason for the unchecked accumulation of wealth.
Economists have suggested a few ways to redirect the objectives of the tax. Firstly, the ‘Angel of Death’ loophole should be removed. This fix has comparatively fewer repercussions and therefore is an easy solution. Secondly, a higher tax rate should be established. It should be noted that this might lead to less risk-taking behaviour by potential investors.
Lastly, the introduction of Accrual Taxation. Under an accrual tax, sometimes called a “Mark-to-Market” system, investors would pay tax on their capital gains every year, regardless of a sale being made or not.
On one hand, accrual taxation would allow for a significantly higher rate on capital gains without allowing for high avoidance. This will enable governments to keep the wealthy in check, all the while bringing in significant revenue.
However, the solution is not without its hurdles. A major advantage of the capital gains tax is that it incentivises long-term stable investment (the lock-in effect: A lower tax rate for a longer holding period), thus promoting savings and steady growth. Changing this feature leads to more erratic investments and large liquidation of potential growth funds (less investing, more hoarding). Even if the tax is capped for the ultra-rich, the ramifications on the economy are difficult to predict.
The Wealth Tax
The idea of a wealth tax has been a point of dispute in multiple forums (including the 2020 US elections). Individuals or families with wealth over a set threshold are taxed an extra amount in accordance with the extent of their wealth. As always, the wealth tax has its pros and cons.
Taking the opposing side into account, the first significant blow to the issue is that it has failed before. Twelve European countries had a wealth tax in 1990; currently, only four countries continue the tax (a limited form). A wealth tax prompted many individuals to move to places with lenient taxation. This phenomenon is known as capital flight (outward flow of large capital) and causes a decrease in economic growth. Another reason for failure was the problem of valuing each asset. Assets can easily be stated at a heavy devaluation when declaring one’s tax records. The few countries with the tax still have trouble in their overall implementation, and tax revenue is minimal.
In India, the wealth tax was abolished in the financial year of 2015–16 as the cost incurred for recovering the taxes was more than the derived benefits.
Economists also state that a wealth tax will prompt more individuals to increase spending and reduce investing, which leads to stagnation of the economy. Finally, the question of necessity comes into play. Progressive taxation already ensures that the brunt of tax dollars comes from the rich (The top 10% pays around 70% of the total income tax revenue of the US- IRS 2018 report). An additional wealth tax is seen as a punishment for progress.
On the plus side, a wealth tax ensures more economic equality and is theorised to bring in considerable revenue if proper execution is done. New policymakers have learned from the European model and have suggested changes to correct previous mistakes. They include heavy penalties for evasion tactics (tax will be collected according to citizenship and not residency), a higher threshold so that only the ultra-rich are involved, and excludes “myriad exemptions” on taxable assets. An ideal solution would be a global wealth tax, but implementing this idea would be one for the history books.
Further research is required to formulate adequate policies to ensure proper distribution and a better quality of life for all. Governments need to step up international cooperation to combat the adverse repercussions and draw a firm line between economic growth and economic equality. The notion of eating the rich is not a new one; the method for realisation remains in the works.
A nation will not survive morally or economically when so few have so much, and so many have so little.
-Bernie Sanders
