Inequality and the consequences: how much is too much?

We’re pleased to share work from Bermudian economist Robert Stubbs, formerly Head of Research for the Bank of Bermuda. We blogged his research on inequality and poverty in the British Overseas territory of Bermuda here. There are more details on him and his work below. Here he asks some searching questions on inequality, looks at the redistributive role of taxation and makes some interesting comparisons between different practices in different countries. Bermuda’s not the only place that finds it difficult to face up to its problems with inequality. And as he so rightly says,

Today, many believe the current system is broken, that it is unfair, and it offers them no hope for the future. Indeed, disillusionment is now so widespread, the legitimacy of government itself in many countries is questioned.  Worldwide, faith in democracy is crumbling.”

Here’s his latest article which was published in its full version by The Royal Gazette in Bermuda here.

Inequality’s Conditional Legitimacy

Robert J. Stubbs

While many may accept extreme inequality’s damaging consequences – such as causing greater residential and social segregation, producing unequal access to quality education, producing less extensive and privileged social networks, not to mention the natural hereditary differences in inherited incomes – many consider effective solutions to these longstanding, widely recognised problems as particularly elusive.  And, more often than not, the seemingly unyielding nature of such intractable problems consigns many to feelings of resignation and despair. I believe a more effective reply to these concerns recognises inequality’s inherent political dimensions.

Without question, income inequality is an intrinsic condition of capitalism.  Any economic system designed to incentivise risk taking will necessarily result in the unequal income of investors. At some point though, greater income inequality becomes self-defeating:

Figure 1

But how much is too much?  How might we judge whether a given level of income inequality is economically, socially and, potentially even, politically harmful? What possible criteria might we apply in gauging whether a country’s inequality is excessive?  While precise evaluations of inequality’s optimal level may be the purview of empirical economists, are there any conditions the public could monitor for telltale signs of inequality’s excess?  Or, to pose the problem slightly differently, are there any preconditions to inequality’s legitimacy?

I believe there decidedly are, and I suggest we begin with the following most fundamental two. The first precondition to inequality’s legitimacy is that the lowest income individuals of a country are receiving enough income to maintain a socially accepted adequate standard of living.  One may quibble over how “socially accepted” is to be determined, but in general it can be considered a consensus of opinion which will vary from country to country.

The second most basic precondition to inequality’s legitimacy is that individuals in the upper half of a country’s income distribution are paying their socially accepted fair share of taxes.  (The economic significance of these conditions is that the first addresses both a symptom and cause of harmful levels of inequality, while the second addresses a significant cause).

The full value of framing the problem as such begins to emerge when we move to its implementation, for how might we apply such criteria?  What economic data would we use in assessing whether these preconditions are met?  If a consensus of opinion is to be formed, what data would the public require in making such an evaluation?

While a host of economic data would be helpful in performing such an assessment, unquestionably the following two would be the best place to start:

Figure 2

1)  A historical incidence of poverty presenting both its current level and change over time (Figure 2), and

2)  A tax incidence analysis displaying the full burden of taxation (in direct and indirect taxes) across a country’s full income distribution (Figure 3). 

Figure 3

Why does Figure 3 refer to 1998? Because that’s when Bermuda’s last tax incidence analysis was performed – and Bermuda’s basic tax structure hasn’t changed since then. An obvious policy implication is that governments worldwide should be producing detailed relative tax incidence analyses.  I think this would go a long way to arresting the “race to the bottom” trend and could even result in significant progressive reform of our tax structures.

And therein lies the rub.  Governments worldwide publish vast quantities of economic data, much of it in exhaustive detail, and yet it is precisely in the areas of poverty and relative tax burdens governments keep their citizens most uninformed.  It is this very information, the data most important to assessing inequality’s legitimacy, governments most guardedly resist disclosing.

I’ve written previously of Singapore’s and Bermuda’s resistance to recognising the full extent of their poverty.  Indeed, Singapore refuses to adopt a definition of poverty, let alone publish an estimate of its incidence, but these are not the only countries whose governments have taken active measures to conceal unwelcome poverty news.  This occurs frequently in countries large and small, in both the offshore and onshore worlds.

Every four years, the German government commissions private researchers to produce an official report regarding poverty and wealth in Germany, crucial sections of which the government routinely amends, weakens or drops altogether prior to its official publication.  The latest report was published last year, after a delay of one and a half years, during which substantial portions were removed concerning the corrupting influence of concentrated wealth on Germany’s democratic process.

Even worse, while the report itself showed a deteriorating poverty situation in Germany, particularly amongst children and the elderly population, in an Executive Summary provided by the government the report’s findings were cunningly misrepresented to the public.  For instance, although the report found over half a million German children living in abject poverty, in households unable to provide such basic necessities as adequate food or heating, the government’s Executive Summary referred to “only few children” living in “conditions of substantial material deprivation.”

In Canada, not only has the federal government long resisted calls to adopt a definition of poverty, effectively framing the determination of an official Canadian poverty line, but the Canadian government historically has shown great difficulty in divulging poverty data required under its international obligations.  For almost 40 years following the formation of the Organisation for Economic Cooperation and Development in 1961, the Canadian government refused to provide the OECD with the data it required to periodically update the OECD’s measure of poverty in each member state.

But if governments globally are reluctant to publish data concerning poverty, they regard releasing information disclosing who pays what in tax as positively verboten. As surprising as it may seem in 2018, for all intents and purposes, the world’s governments have successfully maintained a strict embargo on the public release of relative tax burdens.  (Public registries of beneficial ownership are not the only information governments abhor publishing.)

Of all the world’s governments, only the British government publishes a tax incidence analysis for the public’s review, and, even then, it does so only in sparse detail.  As in Bermuda, the most recent data from the British government shows the country’s highest tax burden is actually paid by Britain’s lowest income households.  Households in the bottom 10% of Britain’s income distribution pay 42% of their income towards direct and indirect taxes.

Once above the bottom 10%, however, Britain’s tax incidence shows a modicum of progressivity, rising from 29% to 35%.  Given the current level of detail offered by British government officials, that’s as much as we can say about tax burdens in Britain.  (Although it is a matter of public record in Britain, some billionaires in London probably pay less in tax to the UK Treasury than their domestic help, an item known only after George Osbourne, in a particular flight of fancy, betrayed as much in the House of Commons).

We know considerably more, however, about tax burdens in France and Germany.  The laborious work required to produce detailed tax incidence analyses was performed by French and German academics in each of their respective countries, and the granularity of their work far exceeds that of the British government.  In both France and Germany, the more detailed analyses reveal the full extent of fiscal favouritism granted their highest income earners.

In fact, such are the benefits extended to France’s highest income households, they actually enjoy the lowest tax burdens of all households in the country.  Above the 96^th percentile of household income, tax burdens become highly regressive in France, with the benefits extended to households in the highest .1% sufficient to lower their tax burdens below those of the rest of the country.

Germany’s favourable tax treatment of high income earners benefits an even greater proportion of the country, albeit the benefits extended are slightly less than those enjoyed by the most fortunate households in France (in more ways than one).  Germany’s tax burden turns highly regressive above the 87^th percentile, with households in the upper .1% paying less than all others in the top half of Germany’s income distribution.

Indeed, the granting of favourable tax treatment to elites appears now to be common practice globally.  Although a full US tax incidence analysis including both federal and state taxes does not exist in the public domain, by all indications the US government bestows even greater benefits on America’s highest income earners.  In a 2011 New York Times op-ed, titled “Stop Coddling the Super-Rich,” Warren Buffett disclosed his taxes paid the previous year cost him 17% of income, while his staff paid between 33% and 41% of theirs.

No doubt, governments have good reason to oppose publishing relative tax burdens.  The unfair tax advantages now routinely extended to financial and economic elites provides damning evidence of the politically corrupting influence of income inequality and concentrated wealth.  What’s more, the severe distributional imbalances in power and influence over our political processes has not gone unnoticed by the general public.

Stagnate wages, rising income inequality and a trail of broken political promises have served to seriously erode public trust in their political and business leaders (Figure 4) worldwide.  Everywhere, many people believe political elites, whether of the right or left, no longer act in the best interest of the public.  Global opinion surveys now suggest feelings of disenfranchisement have reached crisis proportion.

Figure 4

Today, many believe the current system is broken, that it is unfair, and it offers them no hope for the future. Indeed, disillusionment is now so widespread, the legitimacy of government itself in many countries is questioned.  Worldwide, faith in democracy is crumbling.

And this in countries with economies performing much better than our own in Bermuda.  The scale of our crisis makes Bermuda’s circumstances potentially even more volatile.  Last summer, the Progressive Labour Party were elected on a promise of delivering landmark reform.  During the campaign, we heard much of the “Two Bermudas.”  They adopted a slogan of “Putting Bermudians First” and called their election platform, “An Agenda for a Better and Fairer Bermuda.”  They vowed they would dismantle the economic inequities and wrong-headed policies of their predecessors responsible for the island’s economic hardships and preventing Bermudians from achieving their full potential (Figure 5).  In short, they pledged to be both progressive and pro-labour in driving reform.

But, almost a full year on since Bermudians went to the polls, confidence in their political leadership is being severely tested by their distinct lack of progress in developing their promised reforms, by their feverish response to the legislative priorities of Bermuda’s influential finance sector, by their seeming inability to accept the true scale of Bermuda’s economic crisis and by their pursuit of an independence agenda only one in eight of us really supports.  These political circumstances are untenable.  Bermuda’s hesitance in producing the meaningful reforms necessary to redress our structural inequalities and systemic lack of opportunity can persist for so long before, here too, faith in our ability to govern ourselves implodes.

Figure 5

Robert Stubbs is an economist, CFA, holds an International Bond Dealer Diploma and has completed the ACAS actuarial exams.  He was formerly Head of Research for Bank of Bermuda and his professional interests at present lie in enterprise risk management.