Thursday, January 03, 2013

Income Inequality and the Wealth Tax

Responding to Branko Milanovic, Lead Economist in the World Bank research group and a visiting professor at the University of Maryland School of Public Policy, Why Income Inequality Is Here to Stay, in the Harvard Business Review blog.

This article does not establish that "income inequality is here to stay" and beyond the discussion of two political philosophers does not address either the cause of income inequality nor the desirability of ending it.

Income inequality is the result of a structural defect that allows those with more to continue to accumulate more, while at the same time limiting the gains or even forcing losses on those with less. It is the consequence of what might be called a 'scale-free economy', similar to a scale-free network, which disproportionately rewards prior advantage.

Scale-free economics apply not just in the domains of financial wealth, but in other distribution systems as well. For example, web-sites on a given topic created earlier will accumulate more links, all else being equal, than those created later (all else is of course rarely equal). The principle applies independently of the cause of the increased wealth, which is why focusing on specific mechanisms (such as inheritance tax or free education) does not address the inequality.

In nature, inequalities in networks are addressed by physical constraints. A tree trunk can only be so much larger than the branches before it collapses under its own weight. A major airport can only be so much larger that a small airport before being overwhelmed by too many flights. In economics, too, the best and only way to restrain income inequality is the imposition of physical constraints.

In professional sports, franchise owners have learned that income inequality reaches unsustainable proportions unless some form on income or salary cap is imposed; even though the number of qualified athletes is almost limitless, competitive franchise owners will, unless restrained, spend more and more on even the smallest of an advantage.

The same approach would be appropriate in wider society. Rather than address causes, the accumulation of wealth itself should be addressed by policy. Some measures that have come close to this are progressive income taxes and property taxes (the equivalent of baseball's 'luxury tax') but as we have seen, the wealthy are uniquely positioned to find ways around these constraints (thus, for example, Ilya Kovalchuk's17-year contract) as these penalize transfers of wealth rather than actual accumulation of it.

To address income inequality, it should become structurally more and more difficult to maintain large qualities of wealth, either by individuals or by corporations. Accumulations of wealth, such as the trillions of dollars currently being hoarded unused in overseas accounts should be taxed directly. Nations that do not participate in a wealth tax should be penalized financially or excluded altogether from the financial system.

Milanovic's only argument against such measures is the vague and unsupported assertion that "For all but the tamest of these proposals, any popular support is lacking." This is based on his assertion that "Citizens seem to wish for things that are mutually inconsistent: lower inequality, greater equality of opportunity (so that inherited advantages matter less), and a continuation of current low-tax policies." However, these policies are not mutually inconsistent if it is wealth, not income, that is taxed.

Most citizens would be untouched by a wealth tax, for the simple reason that they have none. Upper-middle class and moderately wealthy people would be touched by a tax similar to one they would face today. As wealth rises, the tax would become more significant, and the return from increased accumulations of wealth would become less and less. At a certain point, a maximum sustainable income is reached, at which point, one's personal comfort being assured, people can begin to strive for other objectives.

The concept of a wealth tax, despite being overlooked by Milanovic, is neither new nor untried. European nations such as Switzerland, Germany and France have instituted wealth taxes. It has been discussed by writers such as Edward N. Wolff in Boston Review (1996) and Barry L. Isaacs in U. Miami Law Review (1977). Donald Trump once even proposed a massive one-time wealth tax on the rich, in 1999.

The primary argument against a wealth tax is based on capital flight to tax havens. This is partially addressed by the proposed Tobin Tax on international financial transactions. It is also why a wealth tax requires global cooperation, with penalties applied to non-compliant nations. Recent reports have counted about $21 trillion hoarded, unused, overseas. Taxing this wealth would eliminate the U.S. debt overnight, or if applied globally, would virtually eliminate the crushing impacts of third-world debt while relieving the obligations faced by nations such as Greece and Italy, while still cutting the U.S. debt substantially.

Were the question put to the populations of democracies around the world, in free and fair referenda, support for such a measure would be overwhelming. Indeed, it is hard to imagine how the campaign opposing the measure would be conducted. The more serious issue facing the actual implementation of a wealth tax is the already existing hegemony of the wealthy. It may be too late to recover the trillions of dollars siphoned from the economy. If so, it may be too late not only for the economy but for democracy as well.

I would urge the readers of Harvard Business Review consider ways of alleviating income inequality, and of redistributing the hoarded wealth. This would be far more supportive of business and enterprise than advancing facile and frankly flimsy arguments in support of a structural defect that is pushing the global economy over a cliff.

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