Inequality of wealth is a growing problem in the world today. The disproportionate amount of wealth owned by the top 1% as compared to the remaining 99% is the main theme of protests around the world starting with the Occupy Wall Street protest and the subsequent movement to occupy different financial centers around the world. The United States Congressional Budget Office reported recently that the income of the wealthiest 1% in the US grew by 275% between 1979 and 2007 while that of the bottom 20% of the US population it only grew by 18%. In urban China, the rise in the Gini Coefficient (an indicator of inequality with 100% being most unequal and 0% being most equal) increased by 9% points since 1990 while in urban India it went up by 3% points. The number of millionaire households in China is now about a million and about 200,000 in India both of which are expected to rise significantly.
Excessive concentration of wealth is not good for a stable society and for sustained growth as this reduces the opportunities for those not so well off to do better for themselves economically. Those in posession of huge amount of wealth may also rig the system to maintain the status quo by using their money power in different ways. The rising inequality and the ensuing protests indicate that something must be done about it and that the existing tools are ineffective or used ineffectively.
The rising inequality in the case of India and China indicate economic growth that would first benefit the rich who have access to capital. However it also indicates that Fiscal Policy (Tax Policy and Expenditure Policy) tools need to be used to moderate inequality in these two countries.
Tax revenue as a result of tax cuts have only resulted in falling revenues and with a weak economy, average wages have actually dropped 6.5% from 2000 to 2009 (so much for trickle down). This indicates that tax rates are too low and the US is on the left hand side of the Laffer Curve where lower tax rates imply lower revenues.
Excessive concentration of wealth is not good for a stable society and for sustained growth as this reduces the opportunities for those not so well off to do better for themselves economically. Those in posession of huge amount of wealth may also rig the system to maintain the status quo by using their money power in different ways. The rising inequality and the ensuing protests indicate that something must be done about it and that the existing tools are ineffective or used ineffectively.
The rising inequality in the case of India and China indicate economic growth that would first benefit the rich who have access to capital. However it also indicates that Fiscal Policy (Tax Policy and Expenditure Policy) tools need to be used to moderate inequality in these two countries.
The Kuznets curve formulated by Nobel Prize winning economist Simon Kuznets in the 1950s tried to explain rising inequality during early phases of economic growth and its fall on further development. The inverted shaped U curve shows a high inequality for countries with in the middle of development as indicated by the per-capita income while lower for poor countries and rich countries. There are several explanations offered to the shape of the curve. Kuznets himself suggested that rising inequality during the initial phases of economic development is explained by a move from an agriculture based economy to one based on industries. In fully developed economies, most of the population own either physical or human capital thereby reducing the inequality in income.
This explains India's and China's rising inequality. However, the rising inequality in the United States, indicate a serious problem with this hypothesis. The problem can be explained by a broken Fiscal policy that is not allowing the benefits of economic growth to spread to all.
The richest Americans have a lower effective tax rate of 17% as compared to the middle class and even the poor who pay tax at an effective rate of 22.5%. Since 1992, the tax rates for the rich has decreased ten times as the middle class or the poor. The lower tax rates are based on the principle that lower taxes encourage growth which then creates jobs and better economic conditions for the poor. However, evidence of such a trickle down effect is rather to the contrary.
This explains India's and China's rising inequality. However, the rising inequality in the United States, indicate a serious problem with this hypothesis. The problem can be explained by a broken Fiscal policy that is not allowing the benefits of economic growth to spread to all.
The richest Americans have a lower effective tax rate of 17% as compared to the middle class and even the poor who pay tax at an effective rate of 22.5%. Since 1992, the tax rates for the rich has decreased ten times as the middle class or the poor. The lower tax rates are based on the principle that lower taxes encourage growth which then creates jobs and better economic conditions for the poor. However, evidence of such a trickle down effect is rather to the contrary.
Tax revenue as a result of tax cuts have only resulted in falling revenues and with a weak economy, average wages have actually dropped 6.5% from 2000 to 2009 (so much for trickle down). This indicates that tax rates are too low and the US is on the left hand side of the Laffer Curve where lower tax rates imply lower revenues.There is also the issue of tax compliance. Corporations (and as a result the share holders) are paying much lower taxes as income is moved outside the country to low tax jurisdictions to avoid paying taxes in the US. There have also been several cases of individuals illegally parking their incomes abroad without paying taxes due in the US. Owners of capital in the US never had it better. They enjoy the benefits of lower taxes on their personal income even while their wealth (due to their shareholding in corporations) accumulate in low tax jurisdictions. The trickle down is not happening. It is said that $1 trillion of profits of US corporations is being held overseas.
One sees shades of the same in India with recent proof of large amount of funds that have escaped tax being stashed in tax havens. The rising incomes in India in presence of international tax evasion does not bode well for the future. The G20 countries have given top priority to combating international tax evasion through greater transparency. However, this does not tackle tax avoidance which is legal. This can only be tackled through better laws, stronger tax compliance and stringent punishment for tax evaders.
Surely Tax Policy is facing its toughest test in becoming an effective tool for governments to reduce inequality.
(Disclaimer: The views expressed in this blog are personal and should not be attributed to the World Bank Group)
One sees shades of the same in India with recent proof of large amount of funds that have escaped tax being stashed in tax havens. The rising incomes in India in presence of international tax evasion does not bode well for the future. The G20 countries have given top priority to combating international tax evasion through greater transparency. However, this does not tackle tax avoidance which is legal. This can only be tackled through better laws, stronger tax compliance and stringent punishment for tax evaders.
Surely Tax Policy is facing its toughest test in becoming an effective tool for governments to reduce inequality.
(Disclaimer: The views expressed in this blog are personal and should not be attributed to the World Bank Group)
