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As growth slows in mature economies across the developed world, economic inequality has reached new heights. Defined in terms of the shares of disposable income of households across the economic spectrum, adjusted for varying needs, inequality today in the United States is significantly higher than it was a generation ago. The same is true in the United Kingdom, and even less laissez-faire countries, such as Germany and Sweden, have seen inequality increase dramatically.
The main reason for the rise in inequality is the explosion in gains accruing to those at the very top of the income distribution. But the circumstances of those at the bottom have contributed, too. According to government calculations, the poverty rate in the United States in 2014 stood some four percentage points higher than it did 40 years earlier. In Germany, poverty, as measured by the EU standard, has risen by nearly half since 2000. Europe as a whole has made little progress in aiding the poor in recent years, despite the EU’s pledge to lift 20 million Europeans out of poverty or social exclusion by 2020.
Global leaders have taken note, and they are worried. U.S. President Barack Obama called rising income inequality “the defining challenge of our time,” and Christine Lagarde, the head of the International Monetary Fund, warned of “the dark shadow it casts across the global economy.” But what officials have not said, by and large, is what they would do about it. Many seem to have resigned themselves to an ever-less-equal world.
The good news is that present levels of inequality are not inevitable. If governments are serious about tackling inequality—and that is a big if—then there are concrete steps they can take. Some of these actions might be controversial and difficult, and they would create losers as well as winners. But they are the best practical way to make a dent in a frustratingly persistent problem.
The standard explanation of rising inequality centers on supply and demand. Forty years ago, the Dutch economist Jan Tinbergen described a race between education, which increases the supply of skilled workers, and technological change, which increases the demand for them. Since demand has grown faster than supply, the premium paid to skilled workers has increased, widening the wage differential between them and their unskilled counterparts. Later, globalization entered the picture, causing jobs for low-educated workers in many places to disappear. The policy prescription that flows from this explanation is for societies to invest more in education and training. Such calls are justified, but there is more to the story.
For one thing, the drivers of technological change and globalization are not exogenous, uncontrollable forces. Most technological advancements are the product of decisions made by research managers, businesspeople, investors, governments, and consumers. These decisions affect the degree to which technological change favors skilled or unskilled workers and, more generally, the degree to which it favors capital or labor. A company may, for example, decide to invest in robotizing its warehouses and developing drones to deliver its goods. Those changes would reduce the demand for labor, and the company would no longer have to rely on a work force that wants to be properly treated and paid. But consumers may prefer to deal with a human and not a robot, and there is no guarantee that this preference can be conveyed via the marketplace.
To make sure that the concerns of all stakeholders are represented, governments should take an active interest in the direction of technological change; after all, their grants and labs are responsible for much of the underlying research. When allocating public research funds, governments should consider employment and other social needs. It might make sense, for instance, to shift priorities from driverless cars, which will likely reduce jobs, to technology that helps the elderly stay in their homes, which would increase the demand for caregivers.
The standard story about inequality is also incomplete in that it focuses on individual earnings—the gap between pay at the top and pay at the bottom. It ignores taxes and social transfers, which play a large role in determining how much income a household receives. Since around 1980, developed countries have significantly unwound their policies of redistributing income. To undo the damage, the first requirement is to make income taxes more progressive. In the United States and the United Kingdom, the top marginal rate should rise from 45 percent to 65 percent—closer to the rates that prevailed for much of the twentieth century.
Governments should take an active interest in the direction of technological change.
Governments interested in reducing inequality should also reform the way they tax the transfer of wealth. Namely, they should broaden the estate tax into a tax on all wealth received over one’s lifetime in the form of bequests and gifts. The tax would be designed to reward those who gave away their wealth broadly, rather than concentrating it on one recipient. (John Stuart Mill argued in 1861 that “the State should favour the diffusion rather than the concentration of wealth.”) And to compound the effect, the revenue from the wealth-transfer tax should be used to fund a minimum inheritance for everyone on reaching the age of 18. Such egalitarianism would undoubtedly promote equality of opportunity.
When it comes to government transfers, states should start by focusing on children. In the United Kingdom, the Child Benefit offers a weekly allowance to parents for every child they raise. That transfer should be better targeted by making it taxable as personal income, which would reduce the size of the benefit for those in higher tax brackets. The United States, by contrast, has no such universal program, and the result has been telling: whereas child poverty has fallen sharply in the United Kingdom, in the United States, it rose by nearly a third from 1969 to 2013. Introducing a child-benefit program in the United States would make a major dent in child poverty and represent a powerful investment in future generations.
Just as some governments are providing what is in effect a basic income for children, they should offer everyone what I have called a “participation income.” Under this scheme, benefits would go only to those who participated in society—defined broadly to include not just employment but also self-employment, education, training, job hunting, and caregiving, with exceptions made for the ill or disabled. The participation income would replace the personal tax exemption, by offering everyone the same amount of cash. Although the idea may sound radical, it has found support in the past under the name “negative income tax”—a proposal made by no less a free-market economist than Milton Friedman, whereby citizens whose incomes fell below a certain threshold would receive government payments.
Governments interested in reducing inequality should reform the way they tax the transfer of wealth.
Reducing income inequality is not just about taxes and spending; governments also need to tackle unemployment. Here, the United States has performed better than many developed countries, with its unemployment rate now standing at five percent. But there was a time after World War II when unemployment in such countries as the United Kingdom had fallen to around one percent. Back then, people regarded with horror the prospect that the rate might rise to 2.5 percent; today, the y-axis on the U.S. unemployment chart published by the Bureau of Labor Statistics begins at four percent.
Better is possible. To start, governments should establish an explicit target for unemployment, just as many do with inflation. This is not such a radical idea. The U.S. Federal Reserve, for example, is already mandated by Congress to promote “maximum employment.” Then, political leaders would have to radically reconsider the way they battle unemployment. Past efforts to make the labor market more flexible—the very reform advocated by such bodies as the Organization for Economic Cooperation and Development and the International Monetary Fund—have not succeeded in returning countries to the low unemployment rates of the postwar decades. In large part, that’s because they have focused almost exclusively on the supply side of the labor market. On the demand side, the government can act as an employer of last resort by offering guaranteed jobs. Again, the concept is nothing new: in 1978, the U.S. Congress passed the Full Employment and Balanced Growth Act, which authorized the president to form “reservoirs of public employment.” Jobs are only part of the story, of course, since many people who work remain poor—hence the need to raise the minimum wage.
States wishing to fight inequality will also have to rethink their approach to capital and wealth. Although wealth is much more evenly spread than it was a century ago, there has not been a corresponding democratization of the economic decisions associated with capital. A person with a retirement fund, such as a 401(k) in the United States, indirectly benefits from the dividends paid on shares in a company owned by that fund yet has no say in the decisions made by that company. It is time to rebalance the power among stakeholders. That means taking inequality into consideration when making judgments about violations of antitrust law; after all, as the judge Learned Hand pointed out, Congress passed the Sherman Antitrust Act in 1890 “to put an end to great aggregations of capital because of the helplessness of the individual before them.” And it means ensuring that negotiations about trade deals involve not just businesses but workers and consumer representatives, too.
In terms of the ownership of wealth, plans to reduce inequality have fixated on taxing the rich, but as much attention should be paid to increasing the wealth of small savers. To that end, governments should introduce accounts for small savers that guarantee a positive return in excess of inflation. In the United Kingdom, for much of the past five years, small savers have experienced a negative return on investment, adjusting for inflation. Inflation-indexed savings vehicles would help people accumulate savings, and their use should find support across the political spectrum.
But governments need to look beyond individual wealth to national wealth, since inequality is also a function of the public’s share of state assets. Politicians around the globe obsess over public finances, yet they focus almost exclusively on national debt. Instead, they should look at the overall position of the state: both liabilities and assets. When considering what a state owns in addition to what it owes, things do not look good. The United Kingdom restored its wealth after World War II, and by 1979, its net worth equaled about three-quarters of national income. But after a wave of privatization in the 1980s, the country’s net worth fell sharply, and by 1997, it had nearly hit zero. In the United States, the government’s net worth peaked at around two-thirds of national income at the beginning of the 1980s, fell to a tenth in 1994, and is now negative.
Given this sorry state of affairs, the logical thing for a government to do is bring together its assets in a sovereign wealth fund and design its fiscal policy to build up state net worth. This would not be tantamount to nationalization, since the state would not acquire controlling interests in corporations. Rather, the state would purchase minority stakes in assets that yielded an income, which it could use to finance part of its spending. In the medium term, by acquiring shares in firms benefiting from increased automation, the state would reap some of the increased profits resulting from such macroeconomic developments. As the economist Laura Tyson has said, the implications of robotization depend on “who owns the robots.” If the state gets a significant chunk of the profits—and after all, it paid for much of the development—then the income will be spread far more widely.
The Nigerian writer Ben Okri began a recent poem with: “They say there is only one way for politics.” But, he concluded, “there’s always a new way.” In the fight against excessive inequality, there are alternative ways forward, yet they are not necessarily novel. U.S. Senator John Sherman, a Republican from Ohio, introduced his landmark 1890 Antitrust Act because he believed that among all the country’s problems, “none is more threatening than the inequality of condition, of wealth, and opportunity.” The philosopher Thomas Paine proposed a minimum inheritance as far back as 1797.
Nor do these various proposals need to reduce inequality at the expense of economic performance. To the contrary, if properly designed, the measures can in fact improve the performance of the economy. A minimum inheritance, for example, could help young people finance their education, start a business, or buy property. A higher minimum wage, meanwhile, could nudge employers to develop higher-wage, higher-productivity opportunities for their employees.
Even in today’s globalized world, there is room for national governments to take steps to reduce inequality. For too long, politicians concerned about inequality and poverty have portrayed the problems as regrettable but unfixable. Yet by and large, the solutions lie in their own hands.