Bridging the divide between rich and poor

Needless to say, not everyone agreed with Piketty.

But rising inequality is a concern that is attracting ever more attention in the public debate. Jeremy Swan spoke to Dr Eugene Michaels and Mel Powell, both Senior Lecturers in Economics at the University of Derby, to find out what can to be done to address this growing issue.

Income and wealth

“We first need to be aware of the differences between income and wealth inequality,” begins Mel, “because they are connected but separate issues. Piketty is concerned with wealth inequality, but the problem is we have less data available on wealth. So most of the time, we start by talking about inequality in income, which we have more information on.

“Economists can measure inequality in a number of ways, but the Gini coefficient is perhaps the most widely used method. This is effectively a scale from zero to one, where a lower score indicates higher levels of equality. The UK’s score is currently around 0.35 for income and 0.64 for wealth. Our society is quite unequal, especially when compared to other countries.”

Employment is the biggest driver of income inequality and people’s earnings depend on a wide range of factors including access to work, skill levels and the rate of inflation. However individuals can also use their wealth to generate additional income, through renting out property, for example.

Even putting aside questions over fairness, it is clear that high levels of income inequality come with serious consequences.

“The bottom line is that inequality has a detrimental effect on economic growth,” says Eugene, “because it is the poorer segments of society that slow down productivity. According to the Organisation for Economic Co-operation and Development (OECD), an increase of only three Gini points causes economic growth to drop by about 0.35% per year. Conversely, if you were to increase the income of the bottom 20% of earners by 1% then this would add 0.38% to GDP per year. By redistributing income more evenly, the poorest can benefit from things like improved education and healthcare, which in turn allows them to deliver increased benefits to the economy.”

What is to be done?

Governments can reduce income inequality through cash transfers, of which the benefits system is a prime example. One idea that has gained popularity recently is the introduction of a Universal Basic Income, under which everyone would be entitled to an allowance from the state.

“One of the problems with the existing system is the so-called ‘welfare trap’, where the benefits of going to work are cancelled out by reduced welfare payments,” explains Mel. “A Universal Basic Income would remove a lot of those traps. But to make a real difference to people’s lives it would have to be financed through tax rises, which would be politically unpopular. We also don’t know how it would affect people’s behaviour. Would it disincentivise them from going to work, or would they feel released to pursue their interests?”

Providing benefits in kind, such as free healthcare, is another option: “Evidence shows that education and health are the most redistributive components of government spending,” says Mel. “They really do make a difference and there would be a hugely increased level of inequality without them.”

Governments could also look to reduce income inequality through the tax system. The UK has a progressive income tax system, where the amount you pay depends on how much you earn. The question, Mel and Eugene agree, is how far can you push it? There is a danger that higher rates would encourage people to avoid tax by exploiting loopholes and tax havens.

“You see a lot of lip service paid to tax co-operation and transparency,” says Eugene, “but very little is being done on this, partly because we make a lot of money from tax havens as a country.”

Wealth inequality

One solution to the problem of tax avoidance would be to shift the focus of taxation from income to wealth, suggests Mel: “Wealth taxes – like capital gains or stamp duty – are harder to avoid, and the government could use this revenue to fund policies that promote greater income equality.”

A tax of this kind is Piketty’s solution to the growing wealth divide between rich and poor. Only then, he argued, can we avoid severe social and political upheavals.

“There is evidence that extreme inequality erodes social cohesion,” concludes Eugene, “and in Europe over the last few centuries we have seen how that can lead to conflict and revolution. But ultimately, this all comes down to politics, not economics. If the political will is there, then we can build a fairer society for all.”