Economic inequality is rising. What can we do about it?

In Australia, the share of total income received by the richest 1% of earners has risen from 5% in 1980 to 9% in 2014. In the United Kingdom, this share has risen more sharply from under 6% to over 14% across the same period. In the United States, the richest 1% of earners received a whopping 20% of the country’s total income in 2014, up from just over 10% in 1980(Our World in Data).

This makes the United States the most unequal society among the world’s advanced high-income economies. It also reveals the steady, snowballing extent of economic inequality in the Western world.

Figure 1: Share of Total Income going the Top 1%, 1960 to 2014. By Our World in Data, World Inequality Database (https://ourworldindata.org/grapher/share-of-top-1-in-pre-tax-national-income?time=1960..latest&country=AUS~USA~GBR).

Inequality is not necessarily a bad thing. Most economists would find the notion of a perfectly equal society laughable, given how central the idea of wealth accumulation is to the way we live. In fact, the data shows that low to moderate inequality is useful in spurring national growth and productivity, by creating incentives and competition for innovation(Grigoli, 2017).

What is a bad thing is excessive inequality, the likes of which Western economies are beginning to reach. From the compounding of exclusive inter-generational wealth to the reduced educational performance of the poor, rising inequality has been found to directly impact economic and political outcomes.

For example, the OECD has found that rising inequality from 1990 to 2010 reduced the United States’ cumulative GDP per capita by five percent(Cingano, 2014). Similar effects were found for other rich countries in the study. Additionally, a robust correlation has been found between unequal growth in disposable income and support for radical political parties(Burgoon et al. 2019).

The reasons for this steady increase in economic inequality are disputed, although there are some popular explanations. Aside from neoliberal ideology and the rapid pace of technological change, economic globalisation is the other big scapegoat. With low-skilled domestic workers often being the losers of international trade with developing countries, protectionism seems to be the de facto response by high-income countries.

In the remainder of this article, I will explore two alternative domestic policy avenues available to advanced Western economies. Revising our policies in these fields may allow us to future-proof our economies for the globalised world, and reduce the impacts of excessive inequality.

Progressive taxation

Although the word tax may have a dirty political connotation, in economics it is a primary tool for governments to equalise the surplus from economic activity. In theory, it raises tax revenue from the biggest winners which can then be used to spend on the losers. The steadily rising inequality in advanced Western economies suggests that our taxation systems are failing to redistribute these gains effectively.

The United States’ tax system is exemplary of this. Economists Emmanuel Saez and Gabriel Zucman, in their analysis of total taxation in the country, find it has become increasingly regressive over the past 75 years – meaning that the richest Americans pay lower rates of tax than everyone else(Leonhardt, 2019).

This is due to successive administrations reducing the taxes that most affect the wealthy, such as the estate and corporate taxes. In particular, former president Donald Trump’s 2017 tax cut was instrumental in pushing the tax rate on the 400 wealthiest households below that of most other Americans. Although America’s case may be extreme, countries like Australia – which notably has had zero estate tax since 1979 – share some of its issues.

Conversely, some OECD countries such as Sweden have much more progressive tax regimes and consequently more equal economic outcomes. For example, Sweden’s top statutory income tax rate is at 57.1% and affects citizens earning more than one and a half times the average income, which is a much lower threshold than even the most progressive policy proposals in the United States(Chatzky, 2019).

Naturally, Sweden is a completely different economy with completely different conditions to the United States or Australia. But it is the principles underpinning its taxation systems that other high-income countries should seek to adopt in order to combat rising inequality. Such principles are what contribute to Sweden’s low Gini coefficient of 0.28 for disposable income inequality, 0.06 below Australia and 0.11 below the United States(Our World in Data).

There are, of course, many other necessary reforms in our taxation systems. These include effectively taxing wealth – which includes the financial assets disproportionately owned by the rich – and addressing tax avoidance and evasion by multinational corporations.

But central to all of these reforms are the progressive taxation principles that strive to avoid excessive inequality and its economic consequences.

Accessible education

In the high-income, knowledge-based economies that the Western world increasingly constitutes, the gap between so-called ‘skilled’ and ‘unskilled’ workers is a key driver of inequality. As low-skilled workers continue to be displaced by globalisation and technological automation, education becomes increasingly important in our economies.

Tertiary education has traditionally been considered an endowment for workers, unlocking greater employment opportunities and earning potential. But in the current perilous state of our economies, it is a necessity for financial security – in March 2020, 40% of low-income households lost a job compared to 13% of high-income households in the United States.(Peterson Institute for International Economics)

As college-educated workers with higher incomes adapted easily to working remotely, relatively unskilled and low-paid workers were not afforded the same privilege. With white Americans better able to access the financial capital for higher education, this skilled/unskilled divide often falls across racial lines.

It is then unsurprising that black Americans have died from COVID-19 at 3.4 times the rate of white Americans(Peterson Institute for International Economics). Such statistics are a sobering reminder of the immediate effects of socioeconomic inequality.

Comparatively, Australia’s HECS-HELP loan system is a case of masterful policy design, allowing Australians to effectively defer their payments until they earn past a certain threshold. Even this accessibility, however, has been consistently eroded. For example, the minimum repayment threshold was lowered from July 2019 and from October 2020 the Job-Ready Graduates Package reduced net funding to many courses across all disciplines.

Other systems in advanced economies go further in their recognition of education as a public good for an enlightened and prosperous society. Since 2014, Germany has abolished tertiary education fees. It joins Denmark, Austria, Greece and other European countries in providing free education to its citizens, while tuition fees rise in the United Kingdom and United States.

These European countries recognise that public education is in society’s best interest. It has become increasingly essential for individuals within advanced economies as skilled labour dominates, and this will only continue. But even on a macro level, accessible education is crucial to augmenting the productive capacity of our economy in a globalised world.


References

Burgoon, B., van Noort, S., Rooduijn, M., & Underhill, G. (2019). Positional deprivation and support for radical right and radical left parties. Economic Policy, 34(97), 49–93. https://doi.org/10.1093/epolic/eiy017.

Cingano, F. (2014). Trends in Income Inequality and its Impact on Economic Growth (OECD Social Employment and Migration Working Papers No. 163). https://doi.org/10.1787/5jxrjncwxv6j-en.

Chatzky, A. (2019). Inequality and Tax Rates: A Global Comparison. https://www.cfr.org/backgrounder/inequality-and-tax-rates-global-comparison#:~:text=Sweden%2C%20often%20cited%20as%20the,threshold%20than%20current%20U.S.%20proposals.

Grigoli, F. (2017). A New Twist in the Link Between Inequality and Economic Developmenthttps://blogs.imf.org/2017/05/11/a-new-twist-in-the-link-between-inequality-and-economic-development/.

Leonhardt, D. (2019). The Rich Really Do Pay Lower Taxes Than You. https://www.nytimes.com/interactive/2019/10/06/opinion/income-tax-rate-wealthy.html.

Our World in Data. (n.d.). Share of Total Income going to the Top 1%, 1960 to 2014 [graph]. World Inequality Database. https://ourworldindata.org/grapher/share-of-top-1-in-pre-tax-national-income?time=1960..latest&country=AUS~USA~GBR.

Our World in Data. (n.d.). Inequality of incomes before and after redistribution [graph]. OECD Income Distribution Database. https://ourworldindata.org/grapher/inequality-of-incomes-before-and-after-taxes-and-transfers?country=AUS~SWE~USA.  

Peterson Institute for International Economics (n.d.). How to Fix Economic Inequality? An Overview of Policies for the United States and Other High-Income Economies. https://www.piie.com/microsites/how-fix-economic-inequality