Friday, 27 March 2015

Economic Inequality: Frequently Asked Questions

Cormac Staunton: Since launching our report Cherishing All Equally: Economic Inequality in Ireland we have received a number of questions from a wide range of people interested in the subject. We are encouraged by the level of debate the report has generated and look forward to continuing to discuss this important topic. 

In the meantime, here are our answers to some of the most common questions. 

Q. What is the difference between gross income inequality (also known as market inequality) and net income inequality?

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%.

Top 1% Income and Bottom 90% Income in Ireland 1975-2010 (Source: WTID)
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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.

Rising Average Incomes by Tax Unit in Ireland (Source: WTID)
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Net income inequality is the distribution of incomes once taxes and social welfare payments are taken into consideration. On measures using this data (such as the Gini Coefficient) Ireland scores close to the EU average.

The Gini Coeffeicent in Ireland and the EU (source: Eurostat)
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While gross incomes are measured through Revenue's administrative data, net income inequality is measured through household surveys. Income surveys tend to experience lower response rates from high-income households. Given that these are few in number, under-sampling can lead to significant variation in the data. Sampling can also be challenging from households with very low incomes. 

Q. Does social welfare not reduce inequality in Ireland?

One way to show how a country tackles inequality is to compare income inequality before and after social welfare. Ireland scores very well on this measure compared to other countries. We go from being the most unequal country in the OECD (before taxes and transfers) to around the average when taxes and transfers are included.

Gross Income Inequality (Source: OECD)
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Income Ratio of Middle Income to Bottom 10% (Source: OECD) 
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Gini Coefficient in Ireland before and after taxes and transfers

But the important thing to note is what we are measuring is how hard our system has to work. Ireland is the most ‘progressive’ because we start off as the most unequal. As an IMF staff paper puts it: “More unequal countries tend to redistribute more”. And given the problems caused by rising inequality, Ireland should look to be more than just ‘average’.

Q. Why does high and rising market income inequality matter if it can be redressed through our tax and social welfare system?

There are a number of reasons why market income inequality (before taxes and welfare) is bad both for the economy and for society:

Gross income inequality leads to economic instability
Economic inequality has been identified by many political and economic leaders as among the most pressing problems facing advanced economies. There is growing awareness that inequality undermines economic performance, and was one of the causes of the financial crisis.

The World Bank has stated: “We now know that nations with a widening gap between those who can and cannot access opportunities in life have difficulty sustaining economic growth and social stability over time. To date, no country has managed to transition beyond a middle-income status while maintaining high levels of inequality.” The CEO of Goldman Sachs, Lloyd Blankfein has warned that economic inequality is “destabilizing” and has undermined the ability of the USA to legislate to deal with problems. He has stated that “Too much of the GDP over the last generation has gone to too few of the people.”

It leads to a political power imbalance
Thomas Piketty’s research shows that those in the top one in ten earners are taking an ever greater share of income, even while wages overall are in decline compared to the profits of investors and financiers. 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.

The tax and social welfare system has to work increasingly hard. 
In order to redress the worst effects of high market inequality, Governments use tax revenue to pay for social welfare payments, including for people who are at work. These are resources that would otherwise be available for improving vital public services and investing in productive activity. Such public investments in infrastructure, spending on health and education, and social insurance provision could reduce inequality and increase growth.

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. Globally, the OECD has shown that inequality has led to a fall in the share of economic growth that goes to people at work; for many reasons, from new technologies to the bigger role of finance in the economy. In this way, inequality leads to poverty and social exclusion. But it also lowers demand in the economy in a downward spiral of lost spending.

Q. Is gross income inequality not an inevitable outcome of our market system?

Gross-income inequality is not inevitable. The forces that lead to rising inequality are similar for all advanced economies, but gross income inequality does not manifest in the same way in every developed country. This is because countries can implement specific policies to address rising gross (or market) inequality.

As the chart shows, Ireland Denmark and the USA had similar levels of gross income inequality in the period from 1945 up to about 1980. Since then the three have diverged: in the USA inequality has risen dramatically, while it has fallen in Denmark. Ireland also had rising inequality in that period, though not to the same extent as the USA.

The share of income held by Top 10% in the USA, Ireland and Denmark (Source: WTID).
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Q. Don’t we have a progressive tax system in Ireland?

We often hear that Ireland has “the most progressive tax system in the OECD”. The phrase “most progressive tax system” should of course be “most progressive income tax system”.

The overall progressivity of a tax system should be gauged not only in relation to income tax, but by looking at the effect of all taxes, charges and tax reliefs that make up the whole tax system.

Taxes on consumption such as VAT, which are the same for everyone regardless of their income, make up more than a third of all tax revenue in Ireland. When the tax rate is the same for everyone, people on lower incomes pay a greater share of their total income in such taxes making them regressive. In Ireland, such taxes make up 35% of tax revenue and thus reduce the 'progressivity' of the overall tax system. 

Tax Types as a Percentage of total in Ireland (Source: Eurostat).
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Ireland has the most ‘progressive income tax system’ because we have low taxes for those on low and average incomes which rise to average levels as income increase. Because we start from a low base compared to other countries, we have the biggest ‘jump’ as incomes rise. While this is technically 'progressive', it does not necessarily reduce inequality. 

A notable feature of the Irish income tax system is that ‘progressivity’ is at its strongest between €18,000 and €70,000, i.e. tax increases most steeply within these bands. Thereafter, ‘progressivity’ declines because there are no increases in taxation on higher incomes. This is not captured in the the conventional measures of income tax progressivity. 

Effective Rate of Income Tax/USC/PRSI by Gross Income in Ireland (Source: TASC calculations from Revenue Data).
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Read more here and here

Q. Is growth not more important than reducing inequality?

We have had real economic development in Ireland over the last three decades. New technologies have helped bring a higher standard of living across society and some living costs are lower now than in the past, such as telecommunications or household goods.

Nonetheless, even during recent periods of economic growth, many people’s circumstances have worsened. Essential costs like housing and energy are much more expensive than in the past. And of course, the economic collapse of recent years has devastated the economic position of many people in Ireland.

Up to now we have mistakenly relied on economic growth as the cure-all for economic inequality. But there was no ‘rising tide’. The notion of ‘trickle down’ is a discredited theory, dismissed by the OECD and others. Instead, we need to prioritise reducing inequality and meeting everyone’s material needs, and once we do this growth will follow.

Reversing inequality does not hinder economic growth. In fact, there are strong arguments that more equal societies — like the Nordic countries — have more productive, innovative and sustainable economies.

Q. Why does TASC argue that income and wealth alone are not sufficient indicators of economic inequality?

Economic inequality refers to the unequal distribution of ‘material resources’ — that is the resources people need to attain goods and services to satisfy their diverse needs and to flourish as individuals. Although the discussion of inequality often focuses on incomes, not least due to the greater availability of data, economic inequality is about more than income, since it is only one of the factors that affect people’s ability to meet their needs. Income disparities may matter less in a society with strong universal public services than in a society without them.
Economic Inequaltiy Lens (white background)
Economic inequality recognises that people’s material conditions are also determined by the taxes they pay, the public services they receive, the unpaid work they do and the costs they face. People’s need for goods and services changes over time, due to age, family composition, illness and other circumstances. Men and women may have different needs or face different costs because of the roles they typically take on or are ascribed in society.

Much of what determines people’s earnings is a product of their social background and parental assets. Capacities such as intelligence, creativity, physical and social skills, motivation, persistence, confidence and inherited wealth are not distributed fairly.

Broadening the concept of economic inequality to include all these factors moves the debate beyond narrow measurements like the Gini coefficient of income inequality to a robust sense of the impact on people’s lives of the social and economic system that they live in.

Q. Why does TASC find that Ireland is more economically unequal overall than other countries?

There are two main reasons why inequality in Ireland is higher than other countries. The first is our high level of gross income inequality (before taxes and transfers - see above). 

The second is the combination of low taxes, lower investment in public services ( including social welfare payments), higher charges for public services and a higher cost of living overall.

Low Taxes 
In order to provide public services and invest in our national infrastructure we need to raise money. The amount of public services or infrastructure investment that can be provided is directly related to the amount of tax we raise. Taken the tax system as a whole, Ireland also has far lower taxes and social insurance as a percentage of GDP than the EU average.
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When tax revenue is limited, services will be weaker and this will make society more unequal. If people want more extensive or higher quality public services to be provided in Ireland, greater levels of tax revenue will to be required. Low capital and social infrastructure investment also constrains economic development.

Employers and Employees Social Insurance as a % of GDP in the EU and selected other countries (Source: Eurostat)
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High Cost of Living
A high cost of living makes the economy more unequal. When everyone faces higher basic costs, those who earn less have to spend a higher proportion of their income. Ireland has a cost of living that is 20% above the EU average. Charges for public services have the same effect.

Public Services
In Ireland we provide social welfare cash payments, but we require people to put their hand in their pocket for many services (e.g. GP visits) that might be free-of-charge or subsidised in other countries. So while cash payments reduce income inequality, the higher cost of living and charges for public services increase economic inequality.

Public services play a major role in addressing economic inequality. In particular, they reduce major costs that most people, regardless of their income, could not afford on their own. This is most obvious in relation to education, old age, job loss, disability, illness and the costs associated with raising children.

Public services are also investments that are central to Ireland’s economic prosperity, including roads, electricity networks, support to businesses and education. Cherishing All Equally shows that the way we currently fund, organise and deliver public services in Ireland is not sufficient to reduce economic inequality and to provide quality outcomes for all.Low taxes are an indicator that we provide fewer public services than are provided in other countries.

Low Tax Triangle 
Taking these three together (Public Services, Tax and the Cost of Living) we see that Ireland is stuck in a low-tax spiral. Because we have low overall taxation, we don’t subsidise as many services as other countries. This causes people to put their hand in their pocket for services - GP visits, school books, transport - that would be free-of-charge or cheaper in other countries. Because people in Ireland have less cash after these costs are paid for, they may not see the value of paying more tax. Which means we can’t provide the services… and the cycle continues.
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Q. What solutions does TASC propose?

One of the important contributions of TASC’s report is to demonstrate that economic inequality can only be reduced if policies join the dots between taxes, public services, family and the cost of living; not just focus on cash incomes.

The alternative would be where public services, paid for by taxes, free up cash for people to spend in the local economy and help people to access employment. This creates a ‘virtuous circle’ where more people working and spending in the economy drives economic growth and creates jobs for others. This can be explained using the example of childcare:

Looking after young children is an expensive business, one that cannot be done ‘on the cheap’. Unlike Ireland, most European countries subsidise childcare to make it affordable for young families. This saves families hundreds of euro each month - which is more than any tax cut could do - and gives them more money to spend in the local economy.

And because many parents in Ireland stay home because childcare is unaffordable, subsidised childcare would give more parents the choice to work outside the home. Providing public services (rather than tax cuts) can therefore increase employment and reduce economic inequality, while also making economies stronger and more sustainable.

1 comment:

artied said...

A really excellent article and collection of statistics ...marginally let down by your use of slightly different scale ratios on the very first chart (to no significant distortion but still poor practice...)