Economics
Inequality

Branko Milanovic ... Can Inequality Be Reduced? ... What are the realistic options to tackle the scourge of crass inequality in rich welfare states?

Burgess COMMENTARY

Peter Burgess

Can Inequality Be Reduced? What are the realistic options to tackle the scourge of crass inequality in rich welfare states?

Credit: Greg Brave Shutterstock.com

Takeaways

• Trade unions have become much weaker and their role in private industries has declined in all major countries.

• Globalization makes increased taxation of the biggest contributor to inequality -- capital income -- very hard.

• There has to be a reduction in the inequality of endowments like education and the ownership of assets.

• We need to equalize access to the schools that produce better returns to education and/or equalize returns from education across schools.

This happened not only in the rich countries, but also in many “developmental” states and in all Communist-ruled countries.

This was achieved by means such as, on a “positive side,” mass education, powerful trade unions, increased taxation and social transfers, and on the “negative” side, by hyperinflations, nationalizations and wars.

It is very unlikely that we can rely on the “positive” means again to reduce inequality and one hopes that the world shall be spared the destructive force of the “negative” means.

Consider the “good” factors

Mass education played a key role when the average level of education went up from 5 years after World War II to 13 years today in the most advanced countries.

This made high skilled labor more plentiful and reduced the gap between high- and low-skilled workers thus contributing to a decrease in income inequality. But with many people reaching the “ceiling” in the number of years of education, adding mere years of schooling is no longer feasible.

Trade unions have become much weaker and their role in private industries has declined in all major countries. It is due to the shift of workforce toward services that are much more heterogeneous in types of jobs and also more physically dispersed.

Stronger unions are unlikely to come back: the balance of economic power seems to have, for the time being, shifted to capital.

Taxing the high-income earners

How about higher taxation of labor and capital incomes? Globalization makes increased taxation of one of the most significant contributor to inequality — namely capital income — very difficult.

It may be conceivable only with a fully coordinated action from most advanced countries but that does not seem even remotely possible today.

Two factors are at work here: First, the cross-country mobility of capital makes it very difficult to tax. Second, the countries that benefit from this regime have no incentive to help those who lose.

Moreover, this is not solely an issue of tax havens in micro-states, but of large countries like the United States or the UK. Think, for example, about the recent unwillingness of the U.S. government to investigate and extradite Chinese citizens accused of embezzlement by their government.

A stunning 66 out 100 of “most wanted” persons accused of economic crimes by the Chinese government are thought to hide in the United States and Canada. Likewise, London brokers are all too eager to accept Russian money regardless of its origin.

Even “top labor” – high-income earners — is becoming more difficult to tax. These individuals can easily move from one country to another: there are no obvious reasons why a top executive may not be able to do his job in Singapore or Hong Kong rather than in London or New York.

Skepticism about government efficiency

Finally, the willingness of electorates to tolerate higher taxes on the middle class seems to have come to an end in rich countries.

Perhaps, people just feel that they are taxed enough, or more likely the citizens have lost the trust that the government will use their moneys wisely. Skepticism about government probity and efficiency is much greater today than half-century ago.

This means that the only promising avenue to reduce inequality are interventions that are undertaken before taxes and transfers kick in. These include a reduction in the inequality of endowments, especially inequality in education and the ownership of assets.

Once endowments are less unequal market incomes (that is, incomes before taxes and transfers) will be distributed much more equally than today.

If market income inequality can be controlled, and over time curbed, government redistribution via transfers and taxes can also become much less important.

How can the equalization of endowments be achieved? The role of the government is crucial — although the government does not in this case work on current incomes (by taxing and redistributing them), but over a longer-term trying to achieve an equalization of endowments.

Policies options include

• High inheritance taxes (endowments often differ as parents are able to transfer large assets to their children) possibly used to fund a one-off capital transfer to each citizen when he/she reaches 18 years of age.

• Corporate tax policies could be designed to stimulate companies distributing shares to workers (moving toward limited workers’ capitalism).

• Tax policies could stimulate the middle classes to have and hold financial assets much more then now. In order to overcome fear of losing all of one’s modest investment, governments could guarantee, to small investors, at least a zero net return.

• But this is not sufficient. A more people-oriented form of capitalism is very difficult to realize. Returns from capital are subject to high volatility and the need to have lots of information in order to make considered investment decisions.

The possible solution

Thus, to reduce inequality in endowments, a more widely spread ownership of capital needs to be combined with more equal distribution of education. This does imply not only giving everybody a chance to achieve about the same number of years of schooling, but equalizing meaningful access to education.

What it implies is a reemphasis on state-funded education. The reason is as follows. If the objective is simply to make the number of years of education the same for all, we could conclude that 4 years at Harvard and 4 years at a small state college are of equal value, and the objective could easily be achieved.

But if access to Harvard remains limited to the children of the rich and the returns to 4 years of education at Harvard exceed manifold the returns to 4 years of education at a state college, nothing fundamental will have changed.

Equalize education endowments

There would be a formal, but not an effective equality of education endowments. To do so, we need to equalize access to the schools that produce better returns to education and/or equalize the returns from education across schools.

Such equalization cannot be achieved by force in a market economy since no one can dictate to the firms that they must pay equally people who studied at different schools, regardless of the quality of those schools.

Thus, the only remaining sensible way to equalize education endowments is to make both access to best schools more or less equal regardless of parental income and, more importantly, to equalize the quality of education across schools. The latter cannot be done by anyone other than the state.

Editor’s note: This is an excerpt from Global Inequality: A New Approach for the Age of Globalization (Belknap Press: An Imprint of Harvard University Press, April 11, 2016)

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About Branko Milanovic Branko Milanovic is the Presidential Professor at the City University of New York's Graduate Center, and Senior Scholar at Luxembourg Income Survey. Full bio → | View all posts by Branko Milanovic →