Inequality Is Worse Than We Were Told, and Our Tax System Has Been Covering It Up

by Grace Blakeley

@GraceBlakeley
2 June 2020
  • Estimated read time: 3 mins

Whenever we have heard a whisper of concern in recent years over rising inequality, the right has leapt to remind us that inequality has been flat since the late 1980s and remains low by international standards. This story is indeed borne out by most standard measures of inequality – the income share of the top 1% has, according to standard definitions, hovered between 12% and 16% since the 1990s.

Yet for a very long time, British voters have felt as though inequality is too high. The 2019 British Social Attitudes Survey found that 84% people in the UK believe that the income gap in the UK is too large. The proportion of people who believe that living standards for the unemployed are ‘bad’ is high (29%) and rising (up from 26% in 2006). 

Meanwhile, a study by Oxfam found that 56% of the respondents would prefer a ‘more equal distribution [of wealth], even if the total amount of wealth was reduced’. Just 17% said they would be happy with a more unequal distribution if there was more wealth overall. These findings are echoed by those of similar studies undertaken since the financial crisis – most people think wealth and income inequality in the UK are too high and that the least well off are suffering as a result. 

Rightwingers have a standard reply to the general public: you’re wrong. They assume that people are misdiagnosing the extent of income inequality in the UK and that, when presented with the figures, they would change their minds. 

In fact, it was the figures that were wrong and peoples’ instincts that were right. A recent study undertaken by a group of researchers from Warwick University, the London School of Economics and the Resolution Foundation think tank used an innovative new set of tools to measure income inequality, and found that it is much higher than suggested by standard measures. 

The researchers accounted for income that isn’t received from work, but which represents a return on wealth. This was an important step because the line between income and wealth has become increasingly blurred in recent years, for two main reasons. 

First, our complex tax system has created incentives for people to disguise income from work as income from wealth – for example, by paying themselves through dividends rather than income, thereby avoiding the higher rate of income tax. Meanwhile, selling an asset that has risen in value allows the seller to receive a capital gain (the difference between the value of the asset when purchased and when sold, adjusted for inflation, depreciation etc), which is also taxed at a lower rate than the top rate of income tax.

Second, the growth of shareholder value orientation – the idea that it is the main responsibility of a corporation is to maximise value for shareholders – has encouraged business owners to remunerate senior managers in stock options, in order to ensure managers have an incentive to focus on boosting the share price. Again, the world’s CEOs have largely accepted this state of affairs because in most national tax systems it allows them to pay less tax than if they had received the money as normal income. 

The study from the LSE, Warwick University and the Resolution Foundation argued that some capital gains – for example, those accrued from starting and selling a successful small business – should count as income, and should therefore count towards inequality statistics. When capital gains are included, the researchers found that the income share of the top 1% is 3 percentage points higher than thought, while that of the top 0.1% is 2.5 percentage points higher.

Clearly, these incentives shouldn’t exist within the tax system – income from wealth should be taxed at the same rate, or indeed a higher rate, than income from work. The situation is even more egregious when one considers the fact that the Bank of England has been artificially inflating the value of the assets of the wealthy by creating money and pumping it into the financial system. Assets like residential housing and stocks should have fallen in value much more than they did in the wake of the financial crisis, but action from the Bank of England put a floor under these falls and rapidly restarted a new round of asset price inflation. 

While the wealthy have benefitted from the preferential treatment they receive from the tax system and from central bank monetary policy, working people – particularly young workers stuck with high rents and unable to afford a home – have suffered. 

Tax reform is a favoured hobby horse of many liberals. They frequently point to the existence of inefficiencies, discrepancies and blatant injustices within our tax system, claiming that the system is broken and requires deep reform. The only issue is the system isn’t broken. It is working perfectly well for those who have designed it – the wealthy elites who control our economy and our politics. 

‘Reform’ will only come when these elites are displaced by politicians with an incentive to promote the interests of working people. Aside from anything else, the statistics suggest that they are the only ones aware of the scale of the problem.

Grace Blakeley is an economics commentator and author of Stolen: How to Save the World from Financialisation

Published 2 June 2020

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