Why income inequality must be moderated

By May 22nd, 2012 Uncategorized No Comments

Dr Maheswaran Sridaran

The predominant economic model practised in the world today is free-market capitalism. It is the economic model which has, in all human history, resulted in the creation of the greatest wealth. It therefore has its merits. Chief among them is its propensity to impel human initiative in pursuit of material gain for one’s self, which is a cogent incentive indeed. It rewards, however, only those who are able enough to compete and prevail. Those who can, amass riches. Those who cannot, that is, those who are too weak to compete and prevail, fail, and can fail hopelessly.

Free-market capitalism, therefore, results in some people having high incomes, and others having low or no incomes. That is an outcome with far-reaching ill consequences.  That such consequences do exist must be recognised if the harshness of their impact is to be mitigated though sensible policy measures.

Richard Wilkinson and Kate Pickett, both professors in the UK, in their 2009 book “The Spirit Level—Why More Equal Societies Almost Always Do Better”,  conducted an investigation of the correlation between income inequality and social wellbeing. Wilkinson and Pickett analysed a number of indices of societal health and development across 23 wealthy countries and all states of the USA.

The countries covered in their study included: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, the UK and the USA.

They used the following indices of those countries as measures of societal health and development: mental illness (including drug and alcohol addiction), teenage births, homicides, incarceration, infant mortality, life expectancy, level of trust, educational performance of children, and social mobility.

The following are some of the key conclusions which the authors drew:

  • The wellbeing of children of parents with low incomes is poor, and the prospects for advancement during the life of those children are retarded due to their disadvantaged upbringing.
  • Trust among members of a society can be low where that society is one where income inequality is high.
  • The empowerment of women is low in a society with high income inequality compared to one where it is low.
  • Mental illness is relatively high in societies with high income inequality.
  • Illicit drug use in a society is positively related to the high income inequality in that society.
  • Countries with less income inequality have a relatively low rate of infant mortality.
  • The positive correspondence between a society’s rate of homicide and incidence of incarceration and the income inequality of that society is, indeed, quite strong.
  • Maths and literacy scores are higher in countries with less income inequality.

The book by Wilkinson and Pickett was very widely debated. It was reviewed well by a large number of authoritative critics, but was also critiqued by others as not adequately making the case that it was income inequality which was causative of the societal ill effects that the authors had observed. In other words, those critics argued that the societal ill effects observed by Wilkinson and Pickett were perhaps not necessarily the result of income inequality in those societies.

That inadequacy of income, or more specifically, poverty, can cause the societal ill effects observed by Wilkinson and Pickett is a point that is harder to refute. In other words, some being rich in a society is unlikely to cause those societal ill effects; what can cause them, is some being poor. The alleviation of poverty, accordingly, is the fundamental issue that warrants a policy response, which must necessarily embrace measures aimed at redistributing wealth from the wealthy to the less-wealthy.

All the social ills canvassed by Wilkinson and Pickett  do translate into real economic costs:

  • Poor health and poor education keep the productivity of a nation’s workforce significantly lower than they otherwise would be.
  • A society whose members trust each other less will have higher costs in consummating transactions.
  • Where some are disproportionately richer than the others, those that are richer can deploy their wealth to secure political outcomes that the others cannot, perverting the course of democracy.
  • Inadequacy of consumption (those who are rich consume a smaller proportion of their incomes compared to the poor) is not helpful to propelling growth in employment during times of economic recession.

That these social ills do translate to real economic costs is evidenced by a number of authoritative academic studies. Sir Michael Marmot, a professor of epidemiology and public health at University College London, in an article published in 2006, argued that there is greater prevalence of ill health in the USA compared to the UK, which he attributed to the greater inequality in the distribution of wealth in the USA (compared to the UK) and the consequent heavier mental stresses of those living in the USA experience.

In 2004, Jong-Sung You, a graduate student at the Kennedy School of Government at Harvard University, and Sanjeev Khagram, a Professor of Public Affairs at the University of Washington in Seattle, published a survey of 129 countries, in which they argued that income inequality can engender corruption, especially in countries which are democracies, as in them there was potential for political influence to be secured in exchange for wealth.

As the wealthy become wealthier, they can acquire greater political influence, and they indeed do, to ensure the enactment of policies that support them becoming even wealthier at the detriment of others. That was the conclusion reached by Edward L Glaeser, a professor of economics at Harvard University, in a paper which he published in 2005.

Drawing on the work on fairness by Daniel Kahneman, a Nobel laureate in economics, Steven Pressman, a professor of economics at Monmouth University in West Long Branch, New Jersey,  argued in 2006 that income inequality can lower productivity and reduce economic efficiency. Pressman reasoned that the widespread corporate practice of awarding substantial remuneration to senior executives while insisting on no pay increases, or even pay cuts, to rank-and-file employees will make the latter feel hopeless and may lower their motivation and thus productivity.

In 2004, the American Political Science Association appointed a taskforce to report on the impact of wealth inequality on American democracy. The taskforce comprised 15 academics from the following universities in the USA: University of Minnesota, University of Maryland, Princeton University, Harvard University, Stanford University, Yale University, Notre Dame University, George Mason University, University of California (Irvine), Syracuse University, Northwestern University, University of Illinois (Urbana-Champaign), and Boston College. The taskforce, in their report, unanimously drew the following telling overall conclusion with respect to their country, and it is a conclusion that we in Australia must heed, as our country is a liberal democracy not essentially dissimilar to the USA:

“Equal political voice and democratically responsive government are widely cherished American ideals. Indeed, the United States is vigorously promoting democracy abroad. Yet, what is happening to democracy at home? Our country’s ideals of equal citizenship and responsive government may be under growing threat in an era of persistent and rising inequalities. Disparities of income, wealth, and access to opportunity are growing more sharply in the United States than in many other nations, and gaps between races and ethnic groups persist. Progress towards realizing American ideals of democracy may have stalled, and in some arenas reversed.”

The solution is not the abandonment of free-market capitalism. That would be foolhardy. The solution lies in two broad policy measures. First, there must be an optimal degree of progressivity in the nation’s tax system. Those who are wealthy must, accordingly, be made to pay a greater proportion of their wealth as taxes relative to those who are not wealthy. Second, expenditure programmes undertaken by government must confer benefits not on the wealthy, but on the less-wealthy. The entitlement to benefit from those programmes must, accordingly, be means-tested, unless there are overriding reasons why access to a programme must be made universal without means-testing.

Dr Maheswaran Sridaran is a tax practitioner. He was previously a university academic who taught Australian tax law. His work has been published in prominent Australian newspapers and journals. These are his views and do not necessarily represent the views of The McKell Institute.


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