Can Inequality Be Reduced?

The 20th century is the only sustained period in history when rising mean incomes have been accompanied by decreasing income inequality.

This happened not only in the rich countries, but also in many “developmental” states as well as in all Communist-ruled countries.

On the positive note, this was achieved by means such as mass education, powerful trade unions, increased taxation and social transfers. On the “negative” side, hyperinflations, nationalizations and wars also decreased levels of inequality.

Looking years ahead, it is very unlikely that we can rely on the “positive” means again to reduce inequality. And one certainly hopes that the world will be spared the destructive force of another round of the “negative” means.

Consider the “good” factors

Mass education played a key role when the average level of education went up from 5 years after World War II to 13 years today in the most advanced countries.

This made high skilled labor more plentiful and reduced the gap between high- and low-skilled workers — thus contributing to a decrease in income inequality. But once many people reached the “ceiling,” i.e. the number of years in education, adding mere years of schooling is no longer feasible.

Trade unions, for their part, have become much weaker and their role in private industries has declined in all major countries. This is due to the shift of the workforce toward the services sectors. These are much more heterogeneous in types of jobs and also more physically dispersed, which makes labor organization that much harder.

Stronger unions are also unlikely to come back for another reason: With labor plentiful globally, the balance of economic power seems to have shifted to capital, at least for the time being.

Taxing the high-income earners

How about higher taxation, especially of incomes from capital? Globalization makes increased taxation of one of the most significant contributors to inequality — very difficult.

It may be conceivable only with a fully coordinated action from most advanced countries — but that does not seem even remotely possible today.

Two factors are at work here: First, the cross-country mobility of capital makes it very difficult to tax. Second, the countries that benefit from this regime have no incentive to help those who lose.

Big countries culprits, too

Moreover, this is not solely an issue of tax havens in micro-states, but of large countries like the United States or the UK as well.

Think, for example, about the recent unwillingness of the U.S. government to investigate and extradite Chinese citizens accused of embezzlement by their government.

A stunning 66 out 100 of “most wanted” persons accused of economic crimes by the Chinese government are thought to hide in the United States and Canada. Likewise, London brokers are all too eager to accept Russian money, regardless of its origin.

Even high-income earners are becoming more difficult to tax. These individuals can easily move from one country to another. There are no obvious reasons why a top executive may not be able to do his job in low tax Singapore or Hong Kong — rather than in higher-tax London or New York.

Skepticism about government efficiency

Finally, the willingness of electorates in rich countries to tolerate yet higher taxes on the middle class seems to have come to an end. That, too, reduces the option to generate public revenue for income transfer.

Those who are not as mobile as the top earners perhaps feel that they are taxed enough. More likely, citizens have lost the trust that the government will use their moneys wisely. Skepticism about government probity and efficiency is much greater today than a half-century ago.

Not an easy way out

This means that the only promising avenue to reduce inequality is interventions that are undertaken before taxes and transfers kick in.

These include a reduction in the inequality of endowments, especially inequality in education and the ownership of assets.

Once such endowments are less unequally distributed, market incomes (i.e. incomes before taxes and transfers) will also be distributed much more equally than they are today.

If market income inequality can be controlled, and over time curbed, government redistribution via transfers and taxes can also become much less important.

How can the equalization of endowments be achieved? The role of the government is crucial — although the government does not in this case work on current incomes (by taxing and redistributing them). Rather, it works on a longer-term strategy of trying to achieve an equalization of endowments.

Policies options include

1. High inheritance taxes (endowments often differ as parents are able to transfer large assets to their children) possibly used to fund a one-off capital transfer to each citizen when he/she reaches 18 years of age.
2. Corporate tax policies could be designed to stimulate companies distributing shares to workers (moving toward limited workers’ capitalism).
3. Tax policies could stimulate the middle classes to have and hold financial assets much more than now. In order to overcome fear of losing all of one’s modest investment, governments could guarantee, to small investors at least, a zero net return.

But this is not sufficient. A more people-oriented form of capitalism is very difficult to realize. Returns from capital are subject to high volatility and the need to have lots of information in order to make considered investment decisions.

The possible solution

Thus, to reduce inequality in endowments, a more widely spread ownership of capital needs to be combined with more equal distribution of education. This does imply not only giving everybody a chance to achieve about the same number of years of schooling, but equalizing meaningful access to education.

What this suggests, especially in the United States, is a renewal of the emphasis on state-funded education.

If the objective is simply to make the number of years of education the same for all, we could conclude that four years at Harvard and four years at a small state college are of equal value, and the objective could easily be achieved.

However, if access to Harvard remains limited to the children of the rich and the returns to four years of education at Harvard exceed manifold the returns to four years of education at a state college, nothing fundamental will have changed.

Equalize education endowments

There would be a formal, but not an effective equality of education endowments. To do better, we need to equalize access to the schools that produce better returns to education and/or equalize the returns from education across schools.

Such equalization cannot be achieved by force in a market economy. No one can dictate to the firms that they must pay equally people who studied at different schools, regardless of the quality of those schools.

Thus, the only remaining sensible way to equalize education endowments is to make both access to best schools more or less equal regardless of parental income and, more importantly, to equalize the quality of education across schools. The latter cannot be done by anyone other than the state.

Editor’s note: This is an excerpt from Global Inequality: A New Approach for the Age of Globalization (Belknap Press: An Imprint of Harvard University Press, April 11, 2016)