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A Better World Means Higher Taxes

August 6, 2020 by

Economic inequality has become a hot topic over the last decade. Covid-19, which has hit weaker groups in society harder, has only increased its relevance. It is hard to imagine that the topic was marginalized in  the sidelines of academic literature only twenty years ago. The only way to tackle the issue is to raise taxes.

The improbable hero of inequality is Thomas Piketty. Nobody could predict the superstar status of a French economist, who writes difficult, bulky books, full of statistics . The fact that this man on his own has influenced so much of the debate about inequality demonstrates that first, many people consider this an important topic, second that an overwhelming majority agrees with him that governments should take actions to decrease inequality. His fame is a sign of the times.

The core of Piketty’s work, as I understand it, is that it is a systemic feature of capitalism that capital income is extremely concentrated and is received mostly by the rich. Moreover, the increase in their capital overtakes the increase in their income, and they gradually become more capital-rich. Richer countries thus will ‘naturally’ tend to be more unequal. Branko Milanovic, an expert in inequality, adds that high concentrations of capital income exist in all Western countries and that the US and the UK are no outliers. Contrary to what many might expect, inequality in China even significantly exceeds US inequality, approaching levels in Latin America.

Inequality in income and wealth has been rising worldwide over the past decades.  “Between 2000 and 2018, average wages grew just 0.7 percent per year across 22 countries, (…) less than half the average annual GDP growth of 1.6 percent during the same period,” according to the McKinsey-report The new social contract in the 21st century. Especially the top 1 percent is incredibly rich. Eight individuals own the same wealth as the poorest 3.6 bln people on our planet, according to the NGO Oxfam Novib.

Inequality is an issue that divides societies and that is why it is a problem. People at the bottom of the pyramid suffer from lower mental health, higher stress, more depression, and higher drug and alcohol abuse, resulting in earlier deaths, up to seven years earlier compared to people in richer neighborhoods in the same cities. They experience a declining sense of grip on their surroundings, due to the complexity of society, a distance to policymaking and rising fixed monthly charges. Less grip gives the sensation that anything can go wrong at any moment. Middle incomes can get by on their job earnings, also because goods and services have become cheaper thanks to globalization. But they face a deteriorating capacity to save and they have to spend an ever larger proportion of their incomes on basic necessities such as housing, healthcare, and education. “Coupled with wage stagnation effects, this is eroding the welfare of the bottom three quintiles of the population by income level (roughly 500 million people in 22 countries),” according to the McKinsey-report I just mentioned. Moreover, the wealth that middle classes do possess is not diversified – most of it is in housing – and is highly leveraged. The McKinsey-report adds that inequallity hits younger people harder. “The young have difficulty obtaining well-paid, high-quality jobs and also have a harder time climbing on the housing ladder, with much lower wealth than their peers two decades ago.”

Branko Milanovic, a left-leaning Serbian-American scholar who used to work for the World Bank,  points to three other factors that deepen economic inequality:

  1. Greater homogamy, meaning that people of the same or similar education status and income level marry each other. Both spouses are well educated, from the same social class, they read the same novels and newspapers, dress the same, have the same preferences about restaurants, hiking, places to live, cars to drive and people to see. Assortative mating accounted for about one-third of the inequality increase in the US between 1967 and 2007 and on average 11 percent between the early 1980s and early 2000s in the OECD.
  2. Individuals receiving both high labor income and high capital income. In 1980, only 15 percent of the people in the top decile by capital income in the US were also in the top decile of labor income, and vice versa. “This percentage has doubled over the last 37 years. In classical capitalism, capitalists would be rich anyway and they would have neither the desire nor the time to double up as hired labourers. This may be the product of either capital-rich people acquiring high levels of education and earning high wages, or of high-wage earners saving portions of their salaries and becoming rich.”
  3. A bifurcated education system. In the top38 US colleges and universities, more students come from families in the top 1 percent than from the bottom 60 percent of income distribution. The same process is beginning to occur in Europe. “As the rich realize the advantages of expensive private education, their willingness to pay high tuition enables those schools to attract the best professors and gradually guts the public system of its best teachers and of children from wealthy families. Further, as the rich continue to separate themselves, their willingness to pay taxes for public education diminishes. The eventual result is a bifurcated education system that replicates the distribution of wealth: a small group of top schools attended mostly by the rich, and a large group of mediocre schools open to everyone else.”

Fighting inequality should be done by (radically?) raising income, wealth and inheritance taxes. This is advocated by Thomas Piketty and supported by many, for example a group of 121 millionaires and billionaires, including former Unilever CEO Paul Polman, Disney heiress Abigail Disney and Celtel-founder Mo Ibrahim, who signed the letter Millionaires Against Pitchforks in January 2020. The big question is what consequences, if any, higher taxes will have for the entrepreunerial spirit that is hardwired into capitalism and if they would lead to less innovation, lower productivity, higher prices, less successful companies and thus ultimately to a decline in our incomes. Piketty argues that this won’t happen, Milanovic thinks it will. Even if Milanovic is right, I think that we need higher taxes to increase the feeling of justice in society. Higher taxes are a way to a better society.