US President Donald Trump’s proposed tax reform is supposed to be the largest tax cut in history. It reduces the highest marginal income tax rate as also the corporate tax rate. It eliminates estate taxes. The Tax Policy Center, a US think-tank, estimates that the tax cuts will mostly benefit the rich, with the wealthiest one per cent families earning more than $700,000 receiving an average tax cut of more than $129,000 annually. Trump believes such cuts will lead to higher job creation.
This week the International Monetary Fund seems to have directly contradicted the Trump proposals. At the annual meetings of the IMF and the World Bank, the Managing Director of IMF, Christine Lagarde, urged countries to find ways to redistribute wealth. Her speech and the IMF report are in effect asking for higher taxation of the top one per cent income earners, especially in rich countries. The IMF projects higher GDP growth next year for most countries, but many workers will not see significant improvement in their wages, as technology will replace much of their work.
America has seen wage stagnation for a long time, despite the economy having expanded substantially. Even as the unemployment rate has dropped to lower than 2007, the pre-crisis year, most of the jobs added to the economy are low paying. This means most of the benefits of aggregate income growth are going to the top one or even top 0.1 per cent income earners. This is not a recent trend. This trend is leading to a widening of the rich-poor gap, which is what has been flagged in the IMF’s report called the Fiscal Monitor. Curiously, it is that same widening inequality which has led to political tensions and polarisation, which in turn led to the ultimate election of Trump.
The IMF is very clearly advocating increasing taxes on the very rich, which it claims will not sacrifice economic growth. This is the opposite of the Trump plan. Clearly, one of the two has to be wrong. Both can be right at appropriate levels of inequality in society. Here we have to talk about the concept of “too much inequality”. Inequality, whether of income or wealth, is somewhat like industrial pollution. You can never have it as zero, since you do need to have economic activity. Inequality is a consequence of economic activity, and is inevitable.
But when inequality becomes excessive, it needs to be corrected. How much is excessive is for each society to decide. When it reaches that danger level, you need to introduce redistributive taxes, and increase support for lower income groups. Too much inequality can lead to political instability, flight of capital, social immobility, corruption, charges of crony capitalism and drying up of new investment. Of course, these extreme levels are seen only in a few countries, but in a majority of the countries we are already at worrying levels. The IMF is effectively saying that in many countries we are past that critical level and hence need to increase taxes progressively.]
There is an apparent anomaly here. The fact is that global inequality has actually reduced. This is mainly because of the rise of countries like India and China, so that the gap between per-capita incomes of various countries has come down in recent decades. But intra-country inequality has increased. The IMF report documents this and says that in roughly half of all the 189 countries, inequality has gone up, and is the highest in the past three decades. This is especially true in the US, China and India. Not only have gaps in income and wealth widened, but even inequality in opportunity is greater. Access to quality health and education is becoming very skewed and unequal.
For India, this was pointed out recently in a research paper by Thomas Piketty and Lucas Chancel. Their paper shows that for the period between 1980 and 2014, the gap between the share of income going to the top one per cent income earners versus the entire economy, was the highest in India in comparison to most other countries. In particular, of the cumulative gain over these 35 years, the share that went to the top one per cent was 29 per cent. The top 0.1 per cent earned 12 per cent—a lion’s share—more than the entire bottom 50 per cent. Their report uses tax data from 1922 to 2014. They also admit to data inadequacy and the need for further refinement.
Indeed economist Swaminathan Aiyar has strongly rebutted and said that Piketty and Chancel overestimate India’s inequality. Aiyar of course is more concerned about the implication, fearing that India should not go to the overly statist and socialist policies of the past. But whatever the state of this debate, we cannot escape the conclusion of “too much inequality” in India.
The latest Forbes billionaire report says that the top 100 added 26 per cent to their wealth, much higher than the GDP growth rate, and even higher than the growth in the Sensex. This is just a small corroboration that the spoils of economic growth are very uneven. That is why we use the phrase “inclusive economic growth” as the goal of fiscal policy. This needs progressive taxation, widening the tax net, vastly increased expenditures on human capital formation and reducing gaps in opportunities.
For instance, one of the ways to reduce inequality is to increase the share of women in the workforce, and reduce wage disparity between men and women. Surely that is a low hanging fruit? Can we focus on eliminating the loophole of tax shelters in direct taxes? Can we reduce the burden of indirect taxes, which hurt the poor more than the rich? The list of ideas is long, but the first step is to acknowledge that we are at a point of “too much and an unacceptable level of inequality”. That would be a start.
(Syndicate: The Billion Press)