Tuesday, 24 February 2015

Why ‘gross’ income inequality matters

Cormac Staunton: Cherishing All Equally has prompted a discussion of economic inequality in Ireland. In a previous post I discussed why looking only at incomes is insufficient, and why we also need to look at public services and the cost of living.

In this post I want to show that when talking about income in the context of economic inequality it is important to look at gross income inequality (before taxes and social welfare), not just net income inequality (after taxes and welfare).

Net versus Gross
Ireland’s level of net income inequality is about average for the EU/OECD. For many people this is the end of the discussion of inequality in Ireland. We do enough already. Move along, nothing to see. 

Ireland has average net-inequality because our system is focused on cash. Social welfare payments play a vital role in this, reducing Ireland’s income Gini from 0.53 (pre-welfare) to 0.29 (post welfare), a highly redistributive system. As a result, measures that look only at net-income inequality (or net-income poverty) show Ireland in a positive light.

But these statistics ignore the drag that a high cost of living and paying for public services has on people’s incomes. They don’t include the level of investment in public services. And they don’t address the root causes of inequality.

In Cherishing All Equally we show that this is only one part of the story. When we look at gross-income inequality we see that Ireland is the most unequal country in the OECD, and this has direct implications for the economy and society.

The growing concentration of income
Gross income inequality is the inequality of incomes from the market - including wages, self-employed incomes and investments. When we look these incomes in Ireland over a period of time we see a growing concentration of income in the Top 10%, and in particular the Top 1%.

During the period of economic growth from the early 1990s, the share of income earned by the Top 10% in Ireland rose, meaning that the vast majority of people, the ‘Bottom 90%’ of the population, lost a proportional share of the national income. The Bottom 90% share of national income fell from 71.4% in 1975 to 63.9% in 2009.

We therefore can see a trend towards rising income concentration in Ireland. Nat O’Connor has previously discussed the possible causes of this.  Here I want to expand on some of the consequences.

Economic Impact
Rising gross inequality is related to the declining share of national income going to those at work. Robert Reich demonstrates that during the ‘Great Prosperity’ in the US from 1947 to 1977, there was a virtuous cycle where wages increased, workers bought more, companies hired more, employment grew, tax revenues increased, government invested more, the economy expanded and productivity grew. What we are experiencing across the developed world (including Ireland) is a reversal of this.

Thomas Piketty’s work has shown the negative consequences of gross income inequality for growth. According to OECD data, Ireland has had the third largest decline in the labour share of economic growth between 1990 and 2009: from 65.1% of national income to just 55.6%.

The danger is that it leads to a lack of demand in the economy. Those on low and middle incomes spend more of their money, which drives the economy and creates jobs. With a declining share going to them (and a greater share going to the Top 10%) we have a problem of a lack of consumption. 

While social welfare payments put money in the pockets of those who would otherwise have nothing, these payments are all made at the bottom of the income distribution. While this reduces overall net inequality, it does nothing to address the declining labour share, or the unequal distribution of market incomes. Ireland has 1 in 5 workers on low pay. The high deprivation rate (almost 30%) shows that many people cannot afford to purchase basic goods and services. This implies that welfare payments alone do not drive consumption to a sufficient degree.

As ‘gross’ inequality continues to rise, the question is: how much harder does our tax and social welfare system have to work? How much harder can it work in order for it not to have negative economic consequences?

As the IMF points out, more unequal societies tend to redistribute more. Ireland’s situation (high gross income inequality, offset with welfare cash payments) relies on political will to redistribute cash. But how sustainable is this?

In recent budgets we have seen a reduction in income taxes for those on higher incomes, and stagnation of welfare payments for some, with cuts to others. We have also recently heard discussion of the sustainability of the state pension. Rather than discuss how the pension can be funded into the future, many analysts assume that we will have to cut the state pension.

This highlights another danger from the concentration of income: the political power it can bestow. The Top 10%, and in particular the Top 1%, have the political power to fight against economic policies that will require them to pay more. This power can be used against attempts to increase the level of tax for those on high incomes, or to reduce their income share.

Going Beyond Income
While some of the effects of gross income inequality can be mitigated by taxation and social transfers, there is likely to be a point where growing inequality of market incomes cannot be contained by current, conventional policies.

Some categories of government spending—for example, public investments in infrastructure, spending on health and education, and social insurance provision—can reduce inequality and increase growth. Focusing only on net-income inequality ignores the need for such investments.

Gross-income inequality is not inevitable. The forces that lead to rising inequality are the similar for all advanced economies, but gross income inequality does not manifest in the same way in every developed country. Understanding pre-welfare inequality gives us an insight into the root causes of economic inequality and allows us to look more deeply at our economic and social system.

Cormac Staunton is Policy Analyst at TASC. You can follow him on Twitter @Cormac_Staunton

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