Some perspectives on income inequality in the context of General Election 2020
A core purpose of the Nevin Economic Research Institute (NERI) is to articulate an evidence-based vision of the achievement of a better, fairer (i.e. more equal) society. Lower inequality is associated with a range of quality of life and well-being benefits across the economy and society, ranging from increased life expectancy and happiness, to lower levels of crime and stress. With election season upon us it is therefore worth considering the potential impact on fairness, or inequality, of some of the major policy changes proposed so far.
The ESRI’s Dr Barra Roantree provided a useful backdrop to the discussion on income inequality with his upcoming paper entitled “Understanding income inequality in Ireland”. It is currently unpublished but last Thursday night’s lecture presentation at the SSISI gave us a wealth of interesting results as well as some important suggestions regarding policy.
The paper compares the Irish Republic (Ireland) in 2017 to Ireland in past years (1987 to 2017) and to the other EU28 countries. It uses sample data with a caveat around under-coverage of the very highest incomes.
A key finding is that Ireland has high levels of inequality in relation to household income before we account for the impacts of our tax and welfare system. Ireland then moves close to mid-table by EU standards once we do account for the tax and benefit system.
Overall, Dr Roantree finds that disposable (after tax) income inequality is marginally lower in 2017 than it was in 1987 except at the very top. On the other hand, market income inequality has risen except at the very bottom. Indeed Ireland’s market inequality was the worst in the EU28 in 2017. One reason is the high proportion of households without a market income. For example, Ireland has comparatively low rates of employment amongst single parent households in particular and we have the highest number of single parent households, as a percentage of the total. An obvious culprit for the low employment rate for this group is the extremely high cost of childcare in Ireland (see OECD data), which acts as a major barrier to labour market access for single parents (usually women) and which is itself partially a function of the extremely low level of state spending on childcare.
The significance of income tax policy
Adding pensions and benefits to the analysis does much to reduce inequality, though Ireland is still near the top of the table (5th worst). Significantly, Dr Roantree finds that the Irish income tax system does most to reduce inequality of any EU country and is the reason Ireland ranks mid-table in terms of disposable (after tax) income inequality. He finds that certain features are particularly progressive.
A) The early starting point to the higher rate of income tax (Standard Rate Income Tax Band or SRB); and
B) The five rate Universal Social Charge (USC) levied on a broad income base.
Dr Roantree finds that lifting the SRB to €50,000/€59,000 for singles/couples would cost the exchequer €2.5 billion and would raise the Gini coefficient measure of income inequality to 0.321. This would put us into the top 10 of EU28 countries (i.e. the 10 worst) and near to British levels. Abolishing the USC would cost €3.5 billion (an entire year’s worth of fiscal space) and raise the Gini to 0.325. Either measure would greatly increase inequality in Ireland.
The distributional effect of raising the SRB to €50,000 is stark. All the proportionate gains go to the top 25% of households. Abolishing the USC is even more regressive with huge gains for the top 10% of households and only the top 20% of households doing better than average.
We do not have all of the party manifestos yet so comparison between them regarding income tax policy is not yet possible. We do know that Fianna Fáil (FF) is proposing to reduce the 4.5% USC rate to 3.5%. The Tax Strategy Group puts the cost of this at close to €400 million. FF also have a proposal to increase the SRB by €3,000 for an individual and €6,000 for a couple. This would cost in excess of €500 million. The overall impact of these tax measures would be regressive. Fine Gael (FG) are proposing to raise the SRB to €50,000 an even more regressive and expensive proposal that Dr Roantree’s analysis shows will worsen income inequality. On the other hand, its proposal to increase the USC income exemption threshold will benefit lower paid workers.
Dr Roantree notes that the progressivity of the existing tax system may limit the ability to reduce income inequality. He points out that reducing the generosity of the system of tax expenditure would improve equity. This is because most of the benefits of tax expenditures go to higher earners – he specifically cites the help-to-buy scheme, entrepreneur relief, the tax-free lump sum, and the range of CAT (inheritance and gift tax) exemptions. The NERI has repeatedly highlighted the numerous problems associated with tax expenditures (e.g. here). Tax expenditures generally fail all three tests of a good tax policy, namely, equity, economic efficiency and simplicity.
Dr Roantree makes a number of reasonable proposals for addressing inequality at the bottom of the distribution, he proposes:
- Increasing the Working Family Payment (aka FIS) and expanding eligibility to low income working adults without kids
- Linking benefits payment increases to earnings growth. He notes that not doing so from 2016 to 2020 significantly increased income inequality
- Close monitoring of work incentives – these are quite strong in Ireland. Problems include loss of secondary benefits, level of disability allowance earnings disregarded, and prevalence of means tested schemes such as the Housing Assistance Payment (HAP), NCS and mooted social-care support.
The NERI has repeatedly argued for the tapering or phasing out of benefits (e.g. here). We can remove barriers to employment by ensuring that housing and welfare supports have gradual tapers or phase outs along with increases in income, instead of eliminating them completely along with employment, or some arbitrary income threshold. Tapered in-work benefits have the benefit of redistributing to poorer households, while maintaining incentives to work additional hours and avoiding poverty traps provided the phasing out rate is low.
There is one other area of reform that could reduce income inequality and has, as of yet, received very little attention in the general election conversation. This is the issue of collective bargaining.
Trade unions act to offset the power imbalance that exists in favour of employers by increasing the bargaining power of workers. The effect should be an increase in the average wage rate and therefore the labour share of GDP. A higher labour share implies lower income inequality. Why might this be?
There is invariably greater household wealth inequality in a given population than there is income inequality. Indeed such is the concentration of wealth that Thomas Piketty (2014) estimates 25% of total wealth in France, 30% of total wealth in the United Kingdom and 32% of total wealth in the United States were held by just 1% of the population. As such, we can expect an increase in the labour share of GDP to reduce the level of inequality in the economy by redistributing income away from the owners of capital.
In addition, because trade unions act in the interest of all the workers they represent, their presence tends to help to ensure that the labour share is itself more fairly distributed between the workers in the firm or sector. In other words, trade unions are interested not just in aggregate pay but also relative pay and the greater the scope of a collective bargaining agreement the greater the ability to compress relative pay within a particular sector.
Research from the IMF (Dabla-Norris et al, 2015) finds that less prevalent trade unions and collective bargaining are indeed associated with higher market inequality, while Dromey (2018) uses OECD data to show that higher levels of collective bargaining are associated with lower inequality for OECD member states. There has been a decline in the labour share and trade union density in most OECD countries since the 1970s with larger declines in the labour share tending to occur in those countries with higher falls in union density and collective bargaining coverage. Onaran et al (2015) find that the decline in union density in the UK is responsible for a 4.4 percentage point decline in the labour share of GDP.
Over the long-term equal economies and societies, tend to be more stable and prosperous. Research from the IMF (Kumhof and Ranciere, 2010; Berg and Ostry, 2011) and the OECD (Forster, 2011) indicates that higher levels of inequality are associated with slower rates of growth and are a sign of economic inefficiency. Kumhof and Ranciere identify increasing levels of inequality in the years leading up to both the Great Recession that began in 2008 and the Great Depression that began in 1929 as having a key causal role in both two crises. Berg and Ostry note that:
‘Equality appears to be an important ingredient in promoting and sustaining growth. The difference between countries that can sustain rapid growth for many years...and others that see growth spurts fade quickly, may be the level of inequality. Improving equality may also improve efficiency, understood as more sustainable long-run growth’.
In other words, by reducing inequality, trade unions can play a vital role in sustaining long-run growth as well as the stability of the economic system itself.
If we genuinely want to reduce income inequality, then we need to strengthen collective bargaining.