Reck­on­ing with in­equal­ity

Financial Mirror (Cyprus) - - FRONT PAGE -

There are many ways to mea­sure in­equal­ity. Each can tell us some­thing dif­fer­ent. Many Asian coun­tries’ re­cent eco­nomic suc­cess has re­duced in­equal­ity by some mea­sures (for ex­am­ple, a big fall in the poverty rate), but not by oth­ers (the high-low range has in­creased). In the US, how­ever, all mea­sures of in­equal­ity have pointed in the same di­rec­tion since the turn of the cen­tury, re­flect­ing the fact that the ben­e­fits of eco­nomic growth have gone al­most ex­clu­sively to those at the top. The share of in­come re­ceived by the top 0.5% has reached 14%, where it was in the 1920s.

Nor­mally, one would think that di­ag­nos­ing the cause of such a fun­da­men­tal shift would be a nec­es­sary step in pre­scrib­ing a cure. In that case, one might be dis­cour­aged by the over-abun­dance of plau­si­ble ex­pla­na­tions that have been of­fered and the dif­fi­culty in choos­ing among them.

Thomas Piketty’s Cap­i­tal in the Twen­tyFirst Cen­tury em­pha­sises what he sees as a very long-term trend aris­ing from a high re­turn to cap­i­tal, which causes in­her­ited wealth to ac­cu­mu­late at a faster rate than earned in­come grows. Piketty’s book, pub­lished in 2013, did much to put in­equal­ity back on the agenda of Amer­i­can econ­o­mists. But most re­searchers be­lieve that the sources of widen­ing US in­equal­ity lie pri­mar­ily within earned in­come, rather than aris­ing from the dif­fer­ence be­tween earned in­come (wages and salaries) and un­earned in­come (re­turn on cap­i­tal).

The first ex­pla­na­tion for earned-in­come in­equal­ity is tech­no­log­i­cal change, which raises the de­mand for skilled work­ers faster than the sup­ply. But, while this can ex­plain a widen­ing wage or in­come gap be­tween skilled and “un­skilled” work­ers (de­fined ac­cord­ing to whether they are col­legee­d­u­cated), this has lit­tle to do with the gap be­tween the top 1% and the rest.

The se­cond ex­pla­na­tion is what is called “as­sor­ta­tive mat­ing,” ac­cord­ing to which highly ac­com­plished pro­fes­sional men no longer marry their sec­re­taries, but in­stead choose highly ac­com­plished pro­fes­sional women.

The third is the win­ner-take-all char­ac­ter of many pro­fes­sions, from den­tists to univer­sity pro­fes­sors to movie stars. Be­cause mod­ern me­dia tell us who is the best den­tist in town or the best movie ac­tor in the world, rel­a­tively small dif­fer­ences in abil­i­ties win far big­ger dif­fer­ences in in­come than they used to.

Ac­cord­ing to the fourth ex­pla­na­tion, the very high com­pen­sa­tion of cor­po­rate ex­ec­u­tives, es­pe­cially in the fi­nan­cial sec­tor, is not a re­turn to ser­vices that are in de­mand be­cause they are so­cially valu­able (like hav­ing gone to med­i­cal school or hav­ing been born with act­ing tal­ent). Rather, man­agers es­sen­tially get to set the terms of their own pay, through com­pen­sa­tion pack­ages that re­flect fail­ures of cor­po­rate gov­er­nance, tax law, and fi­nan­cial en­gi­neer­ing. Stock op­tions, for ex­am­ple, have failed in their orig­i­nal goal of re­lat­ing pay to per­for­mance.

Fi­nally, an es­pe­cially pop­u­lar ex­pla­na­tion is that the rich have cap­tured the levers of power, through cam­paign do­na­tions. The politi­cians they fi­nance are only too ea­ger to en­act favourable poli­cies.

But many pol­icy pre­scrip­tions to ame­lio­rate in­equal­ity ap­ply re­gard­less of the cause. Most would make the tax sys­tem more pro­gres­sive, by, for ex­am­ple, low­er­ing the ef­fec­tive marginal tax rate for low-in­come work­ers – what US Pres­i­dent Barack Obama has called “mak­ing work pay.”

En­hanc­ing the earned-in­come tax credit is a live op­tion to­day, and Obama pro­posed in his Jan­uary 2016 State of the Union ad­dress ex­pand­ing wage in­sur­ance, which cur­rently helps work­ers who lose their jobs be­cause of trade but could be ex­tended to those who lose their jobs due to tech­no­log­i­cal change. Sim­i­larly, the pay­roll tax for low-in­come work­ers could be elim­i­nated.

In light of loom­ing deficits for Amer­ica’s So­cial Se­cu­rity and Medi­care pro­grams, such changes in the tax code should ideally be rev­enue-neu­tral. The Repub­li­can can­di­dates for pres­i­dent this year, as usual, pro­pose mas­sive tax cuts, fo­cused on the rich, with­out a plan for how to pay for them.

The US can raise ad­di­tional rev­enue with which to ad­dress in­equal­ity in fis­cally re­spon­si­ble ways. The tax break for “car­ried in­ter­est,” by which hedge-fund man­agers’ in­come is taxed at low cap­i­tal-gains rates, should be abol­ished (as Demo­cratic pres­i­den­tial can­di­date Hil­lary Clin­ton favours), and the ex­emp­tion for the es­tate tax (orig­i­nally ex­panded by Ge­orge W. Bush) could be re­duced. At the same time, the cap on pay­roll taxes for up­per-in­come work­ers could be raised, and dis­tort­ing tax de­duc­tions, like that for mort­gage in­ter­est, could be tight­ened for up­per-in­come house­holds.

A lot should be done on the spend­ing side, too. Ex­am­ples in­clude uni­ver­sal high-qual­ity preschool, health in­sur­ance for all, and in­fra­struc­ture spend­ing.

Many of those who are up­set about in­equal­ity are at­tracted to the ban­ner of Bernie San­ders (or that of Don­ald Trump). Many be­lieve that one must break up banks in or­der to ad­dress the root cause of the prob­lem, which is thought to be that the rich have “bought” politi­cians.

Money in pol­i­tics is in­deed a big prob­lem. But what do politi­cians use all that money for? It doesn’t go into their pock­ets (at least not in the US). It goes to run­ning for of­fice: cam­paign ad­ver­tise­ments and mo­bil­is­ing sup­port­ers. In my view, vot­ing for can­di­dates who will en­act the right poli­cies is a far more di­rect strat­egy for ad­dress­ing in­equal­ity – and much else – than vot­ing for those who want to break up the banks to re­duce the amount of money avail­able to dis­suade vot­ers from sup­port­ing the right can­di­dates.

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