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Get radical says the Economist – time for new thinking on tax and welfare

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Research by economists at the IMF suggests that income inequality slows growth, causes financial crises and weakens demand

Confirmation came this week that turning a blind eye to the inequality and poverty in our midst is as dumb as it gets. Not mean-spirited, although you could argue that too, but plain dumb.

On October 13th the Economist produced a special report on inequality and called for ‘True Progressivism” (Here is a small online piece).

In that report it tabled the mounting evidence that inequality damages the prospects for everyone, not just those unfortunate enough to be struggling on low incomes.



..the economics establishment has become concerned about who gets what. Research by economists at the IMF suggests that income inequality slows growth, causes financial crises and weakens demand…More controversial studies purport to link widening income gaps with all manner of ills, from obesity to suicide…A survey for the World Economic Forum meeting at Dovos pointed to inequality as the most pressing problem in the coming decade (alongside fiscal imbalances). In all sections of society, there is growing agreement that the world is becoming more unequal, and that today’s disparities and their likely trajectory are dangerous.

It’s not that inequality per se is bad, the problem is the size of the gap and how we got here. Paying talented, innovative risk-takers is necessary if you want a dynamic economy and society – so you will always have to accept some spread of income and wealth if you want to live in a thriving community.

But you don’t want the gap between the haves and have nots to become so large that radical political movements emerge that end up helping no-one, just redistributing what already exists and proving very poor at generating new wealth. The former eastern bloc countries are a classic example of this. Last year’s August riots in London are a teaser of what can occur.

Also when the gap gets too large, it becomes near-on impossible for talented youngsters from poor backgrounds to leap the divide and achieve to their potential, and we are all the poorer for that. Our economy won’t deliver unless our talent, wherever it comes from, can rise to the top.

Equally concerning is the fact that this recent widening in inequality has been caused not by talented people getting just rewards but by rules allowing some people to exploit political connections and consumer ignorance. The banking sector is a classic example of this. Success in persuading governments that catastrophe would follow if banks were allowed to fail meant bank executives could take high risks, share the high rewards among themselves when the risks paid off and pass the losses on to the tax payer when they didn’t. Weak consumer protection laws meant finance sector firms passed on ridiculous risks to their unaware customers while all the time pocketing a high and steady fee. This excessive remuneration in the finance sector arguably set a benchmark for other executives, lifting pay at the top for many industries.

Another contributor to widening inequality reported by the Economist and blindingly obvious in New Zealand is the presence of glaring gaps in the tax-system. Exemptions which can be exploited by those with wealth have – surprise, surprise – allowed the wealthy to get richer faster than everyone else. In New Zealand the most obvious exemptions relate to land and housing but there are others too, which allow capital gains on financial transactions to be exempt from tax.

The Economist calls for a ‘radical’ rethink – keeping to the same tax approach and tinkering with it just doesn’t cut it. Lifting top tax rates when your tax base is so leaky is pointless – in New Zealand it will only drive more investment into unproductive housing where the exemptions are, and out of business, doing nothing to boost revenues or reduce inequality. We need to close down those holes by taxing wealth whether it is invested in housing, land or something else.

The other side of inequality and the redistribution which addresses it is of course the welfare system. The Economist calls for greater targeting of benefits, but also new approaches, and points to the lessons to be learned from Latin America. We’d disagree that increased targeting makes sense for New Zealand – we simply can’t afford the dead weight costs of administering a tightly targeted system. The army of bureaucrats and consultants that deliver our present system costs hundreds of millions of dollars a year. Nor can we afford the indirect costs that targeting brings, like discouraging part time work.

We’d agree there is much to be learned from Latin America. Capital-based taxes like the one we recommended in the Big Kahuna have been recommended and implemented there. And the Brazilian family support policy the Economist reports as promising has more in common with the universal child payment recently recommended by the Expert Advisory Group to the Children’s Commissioner than the current system of targeting of child benefits in New Zealand which depends on parents working a minimum number of hours a week.

We’d agree wholeheartedly with the Economist that it’s time for new thinking and new solutions. What’s needed too – and what is most obviously lacking – is political courage

“At the core, there is a failure of ideas. The right is still not convinced that inequality matters. The left’s default position is to raise income-tax rates for the wealthy and to increase spending still further…A far more dramatic rethink is needed: call it True Progressivism.”

  • Luke Benton

    We live in a world where we currently have the knowledge and
    technology to enable an acceptable standard of living for ALL HUMAN BEINGS
    while simultaneously reducing the average hours worked. The failure of ideas we have is a failure to accept logic, compassion, and knowledge of natural systems into our currently held economic (social and legislative) beliefs. In order to address our problems we, as a nation, must take a good long look at the practice of artificially inflating consumption through ‘perception management’ (in media, advertising, politics, ‘pop’ culture) promoting unrealistic (not fitting with natural principles) ideals. We must question the logic behind having private corporations controlling the creation of debt/credit (and the absurd levels of interest charged). We must take note of the reality of believing continual growth is a good thing and the implicit converse that economic sustainability is bad.
    The fact of the matter is that no amount of tinkering to our currently accepted
    economic system is going to work out for our species in the long run. Modern
    society has become physically comfortable and this has been exploited with the
    effect of making us ideologically comfortable (read numb). It seems as though
    our species has been caught in (our perception managed to maintain) a false belief that to ask the pertinent questions and address the intellectual rot within our economic, legislative, and social systems will mean a catastrophic disruption to the pleasures of modern society. This is a lie. The only way our species can move forward without devolving into various levels of self destruction is to challenge economic dogma and rewrite our systems of regulation to the best knowledge, logic, compassion, and wisdom allow. This will all be kick started as soon as we wake up and, as a nation, take back control of our economy (starting with creation of our debt/credit) from the hands of private (self interested) corporations.

  • debbie

    When there exists a delusion of grandeur for those who have more, there will always be some who are prepared to step on others to place themselves at the top of the pile. Maybe voters should be educated to judge trees by their fruit before they go to the polling booth.

  • Zenguy

    Our growing inequality is a symptom of the Industrial Age thinking that has dominated New Zealand economic policy.

    In the Industrial Age, wealth generation came from the application of capital. If you wanted to produce something you needed ‘heavy’ capital: land to produce the raw materials; heavy equipment to transport and manipulate them, buildings to house the equipment and workers that operate it. The industrial age was the time of commoditisation, of economies of scale, when bigger really was better. In that environment, it made sense to concentrate wealth into the hands the few who knew how to put it to good use.

    We aren’t in the Industrial Age any more. We are in the Information Age. The world economy has realised the potential of commoditisation and has moved on to discovering the potential of customisation. (Just look at the changing nature of work: the majority of people work for organisations that didn’t exist 30 years ago, doing jobs that people didn’t exist 20 years ago, using equipment that didn’t exist 10 years ago).

    There are economies of scale in the Information Age, but these are more and more economies of people scale rather than capital scale. Take Google, Apple, Facebook, Microsoft for example – organisations that represent the growth, nay dominance, of the knowledge economy, yet all of which got their start, not in well appointed corporate boardrooms, but in the shabby kitchens and lounges of previously unremarkable people. They illustrate the success of economies of human scale, of large pools of educated knowledge workers with diverse backgrounds and experience with the lifestyle capacity to share and develop. (I’m looking forward to the day when the National Party get beyond the
    stock “we need more corporate investment in R&D” and start showing
    some real insight into the knowledge economy.)

    New Zealand can never hope to match the knowledge working scale of California, let alone the USA. But we sure as hell need to try, because we aren’t going to get anywhere by being just another agricultural producer (look what that strategy has done for our OECD rankings over the last 50 years).

    To compete effectively in the modern knowledge economy, we need to be developing as many of our people as we can to be potential contributors to our knowledge economy. Necessity may be the Mother of Invention, but in single parent family Invention’s chances aren’t great. Invention also needs a Father; one that supports as many of his children as possible to contribute to the melting pot of knowledge, application and ideas – because it is from that melting pot that invention, innovation, and ultimately the future of New Zealand will arise.

    We need another 50 Peter Jackson/Weta Workshop’s across a range of
    fields if we really want New Zealand to maintain (or perhaps even
    recover) our standing in the OECD.

    Which brings us right back to inequality. We need as many people as possible contributing (in some way) to New Zealand’s knowledge economy. Which means we need to reverse the accumulation of opportunity in the wealthy and instead make it far easier for any New Zealand citizens to participate in our knowledge economy. In short, we need to bring back, and embed into our social and economic infrastructure, the opportunities that enabled our very own John Key to rise from his humble beginnings to become Prime Minster of this country. (Just how well would John Key have done if his mother hadn’t had enough money to give him breakfast every day before school?)

  • Shaun

    I agree, closing tax loopholes is obvious, but like you say, where’s the political courage? The predictions of Dr Ravi Batra (US economist) is that equality will not occur until the end of crony capitalism, and productivity is brought in line with wages, through a Proutist type system. Picture companies in 50% ownership by the workers, and top CEO salaries capped. London riots, the Occupy movement are predicted to be the tip of the iceburg leading to needed social revolution
    When the bulk of wealth is held by so few, will tinkering with taxes and welfare be enough to bridge the widening gap in our society?

  • Michael Wood

    Thanks for posting this. I haven’t read the full article, but one obvious omission from the above analysis is the structure of labour markets. If inequality is a concern then the overwhelming evidence from comparative studies between countries, and within countries over time, is that if you weaken effective collective bargaining, then you increase inequality.

    It is of course not the only piece of the puzzle, but I don’t think we can really develop a solution to inequality without addressing the mechanism by which most people actually receive their incomes.

    For plenty of us on the left, it is just as, if not more appealing to get the ‘pre-distribution’ part right (inclusive of productivity, equitable labour markets, and skills/training/education) than it is to clean up the mess later on by endlessly re-distributing through tax and transfers (although they will always be part of the mix).

  • UnifiedNZ

    Great to see this issue rising to the surface, simply impossible to be ignored. First I would like to make an observation on the illusion that becoming more productive generates NEW wealth. Increased economic activity merely shifts wealth around unless the money supply is increased via new debt or new foreign investment/increased exports. Having economic “growth” as the focal point, is steering the ship in the wrong direction. Our collective fear that inflation is the devil is getting in the way of us truly managing the dynamics of a thriving economy. Inflation is of course the result of too much money chasing too few goods, hence prices go up. The perceived horrors of becoming unappealing to foreign nations as a country to import from keeps us firmly entrenched in our current way of being. The fantastic news about the precursor to inflation is that for a period, overall demand for good and services is in fact exceeding supply. (due to new money being printed and increasing the money supply with no debt attached for example) What better opportunity is there for local producers to meet this demand organically from within our own country, hence creating the opportunity for new industries to emerge etc. The CRITICAL piece of work that will need to follow is that the money supply needs to be monitored and managed by treasury to ensure the amount of money available in the money supply generally doesn’t exceed the amount of goods and services available. This way government can spend money into the money supply (with no debt attached might I add) and disperse it evenly throughout the economy. (via a social dividend for example) We already know that money spent on developing infrastructure in relatively non-inflationary yet we still borrow money for this rather than printing it with no debt attached. Not to digress here but the other point I want to make is that money has become a commodity. In reality it’s value should be derived from the commodities that uphold it. Money unlike pretty much all commodities grows in value yet money was only created to facilitate the exchange of commodities. Once someone has a chunk of money there are many incentives for that person NOT to spend it on stuff that produces and contributes to the prosperity of the nation. Earning money through passive ownership of property is relatively easy once you have some physical capital behind you. So a collection of seemingly small issues are exacerbating the issue of inequality in a seemingly subtle manner yet some very logical and relatively simple changes will have a profound impact and will make us utilise the resource and capital we have within our nation that is currently being hoarded and sat on doing absolutely nothing to contribute.

  • Ross Calverley

    You would think it was obvious really. Capitalism actually works on the principles of supply and demand. Having a job means that you are supplying a good or service and have the means to spend on other goods and services from your labour.

    As for the welfare system, Gareth, although having read your book, I’m unconvinced that a universal benefit would work as well as you propose. Someone who is sick or was an invalid would be severely disadvantaged as they would not get any support for their medical bills, some which they receive now.

    One clear benefit I can see that a UBI would mean that there is no disincentive to work. A problem with the current system is that for every dollar you earn after $80 gross (or $100 gross, depends on the benefit), you pay WINZ 70 cents in every dollar you earn. That wouldn’t be so bad, but you have to pay secondary tax of 30 cents in the dollar, then ACC levy of 1.7 cents and finally a KiwiSaver of 2 cents (or more). This means after that number (80 or 100) beneficiaries are working for a negative rate of pay. It takes courage to actually go and work, knowing you are loosing money for another hour of labour.

    As an aside Gareth, could you explain why we have a system of secondary taxation? I cannot understand why we have it.

    • Anthony Woolcott

      Secondary tax is really only an estimate tax of what you’re likely to need to pay. Your actual tax rate you pay is determined by the income you earn for the year. So 2 people earning exactly the same gross wage, will still pay the same tax even if one is on secondary tax. It will be balanced out at tax-return time. For example – If your tax rate for the year should have been 20c in the dollar and you’ve paid 30c in the dollar secondary tax – you will get the difference back that you’ve overpaid.

  • Andrew

    So, there are two choices it seems, that people make. One to be productive, and one to be non-productive. I fail to see how taxing property will encourage the non-productive into a productive role.

    • cmoman

      Taxing property will reduce lending to those speculating in property or just caught up in property booms. Lending to a business or a property buyer will then be on a level playing field from a tax perspective. More money will then be available to businesses at cheaper rates. Or foreign capital won’t be invested in New Zealand property to the same degree. It will either go into NZ business or not at all. This will take the heat off the dollar and allow exporters to be more profitable. Imports will go up in price, perhaps revitalising some NZ business through domestic production.

  • Peter Quixote

    Solutions do not include a massive new tax . In NZ we already have tax on income and tax on spending, we do not need to impoverish people further with a tax on the peoples assets. The Gareth Morgan site is so loose on detaill that all hids accountant riends are laughing .
    go here

    • cmoman

      I’ve read your blog and your objections are well, weak. You pick the weakest example and suggest that the state should always support someone in the lifestyle to which they have been accustomed to yet haven’t prepared for. What is wrong with retired people that have not made provision for themselves, moving out of New Zealand’s most expensive city in order to improve their financial situation. The merits of Gareth’s proposals are enormous and yet you wish to pick the bleeding heart case in a bid to dismiss it. Gareth has been quite clear in his book that there would need to a transition phase to protect people in the circumstances you describe or presently nearing retirement. But this does not negate the fundamental benefit of the CCT establishing sensible property prices, curbing land speculation and the UBI massively simplifying the welfare system.