Gray's Economics: September 2016

Well done Jack Haile for being awarded a Highly Commended in the 2016 RES competition. "The overall standard of essays this year was really high so to reach the commended category from a total entry of 1,690 essays is a notable achievement!"

Jack's award winning essay:

Does rising inequality warrant the imposition of higher income and inheritance taxes on the rich?

Inequality is the greatest threat humanity faces in the 21^st century. An issue less overtly terrifying, but much more sinister, than civil war, global warming or Islamic extremism, for inequality is often the driving force behind these catastrophic world events. Whether it is social division causing conflict in Ukraine ^[1], reduced tax receipts limiting the UK’s ability to fund environmental subsidies ^[2]or sky-high levels of unemployment driving young men to extremism in Iraq ^[3], inequality remains the underlying factor in common. This is not just a case of the rich growing richer and the poor becoming ever more destitute; this is a case of many feeling that the rich are deliberately exploiting the poor in the workplace, in government and throughout their lives. This essay will explore both the positive and negative effects of inequality and evaluate the effectiveness of increased taxes, both income and inheritance, which aim to mitigate its ramifications. It will assess the truth behind the trickledown philosophy and find that a rising tide does not lift all boats.

If the National Minimum Wage had kept pace with FTSE 100 CEO salaries since 1999, it would now stand at £18.89 per hour instead of £6.70 per hour ^[4]. However, inequality cannot just be defined by wage differences; it is a far more complex and ingrained social issue. Inequality affects our lives from the moment we are conceived. In Australia, perinatal death, between 2001 and 2004, was twice as likely for infants born in public hospitals than in private ^[5]. This theme is reflected world over with private healthcare having lower infant mortality rates in countless countries. Thus inequality not only affects our lives from the moment we are born but also dictates whether or not we are born at all.

Inequality follows the lives of many into childhood, through the vast disparities between the quality of private and state-funded education. In the UK more money is spent on private education than anywhere else. The best-off 7% of children in Britain have three times as much spent on their schools than the average child in the other 93% ^[4]. Consequently, the less fortunate have their opportunities limited from the offset. The cycle of inequality is repeated as children from lower socio-economic backgrounds are hampered in their ability to attend top universities and gain high paying jobs. As a result of their lack of qualifications and limited job prospects these individuals cannot afford to send their own children to private schools or even move into more expensive catchment areas for the ‘better’ state schools there. The cycle of inequality is thus complete. However, many argue that this is not the case and that instead inequality acts as a driving force for the underprivileged, motivating them to work harder and save more in the hope of escaping this vicious cycle. But is there any evidence that inequality is beneficial to society?

We are morally ingrained to believe that inequality is ethically wrong. This ‘truth’ has been hammered into us from birth as part and parcel of our consciences, to the extent that the term ‘inequality’ is now used as a synonym for ‘unfairness’. But if we pause for one moment, and ignore the stubborn swing of our moral compasses, could it be envisaged that inequality is ultimately a force for good, at least in an economic frame of reference? Some might argue that inequality benefits everyone, no matter where we lie on the social spectrum, stating that it is a tool used by the capitalist society we live in to ensure a minimum standard of living for all.

On October 3, 1963, President John F Kennedy famously popularised the phrase ‘A rising tide lifts all boats’ ^[6]. This metaphor succinctly summarises the economic trickledown philosophy that suggests that if the economy is experiencing growth, namely, if there is a real increase in GDP per capita, then the benefits of this growth should be felt across the economy regardless of individual socioeconomic positions. If only Kennedy had been aware of the damaging connotations that this quote would come to represent. In an effort to justify the increased wealth of the rich this phrase is time and time again employed in defence of tax cuts, as a rebuttal to calls for the redistribution of wealth, and as a side-step to claims that the poor’s exploitative work conditions and wages are unjustifiable, all based on the reasoning that increased wealth in the higher echelons of society supposedly benefits us all. This is a fallacy, which has led to a culture of millions idealising the rich as all-powerful wealth creators for each and every one of us. Why? Because whilst average UK incomes have only just recovered from the worst economic crisis since the Great Depression, British billionaires have seen their net worth double since the recession ^[7]. It is clear that creating wealth at the top, of which inequality is a by-product, does not benefit the majority.

On May 6^th 2016, “John Doe”, the source behind the largest information leak in history consisting of 11.5 million released documents, named income inequality as a primary reason for his release of these ‘Panama Papers’ ^[8]. This leak highlighted the imbalance of power and wealth in the world and why income and inheritance taxes are ineffective in righting the scales. The papers revealed nearly 214,000 offshore entities ^[9], demonstrating the ease by which taxes are avoided and on such a colossal scale. Income and inheritance taxes are only as effective as the legislation that prevents their avoidance. Where there are gaping flaws in the system, as in the UK where the tax gap, the difference between tax revenues and the total sum that could potentially be collected, is £34 billion ^[10], increasing income and inheritance taxes will be inadequate in solving inequality.

Raising income taxes would not harm the wealthy but would instead harm the individuals for whom increased income and inheritance taxes were intended to help. This is because those on low incomes cannot afford to evade taxes since the cost of doing so renders the act unviable. Equally, most workers both public and private sector, lack even the option to reduce their tax payments as their salaries are taxed prior to their receipt of them. Consequently those who deserve increased taxes the least are the most susceptible to their effects. Higher income taxes additionally attack the lower-paid as they act as a disincentive to work. As marginal tax rates increase, individuals may not take on more hours of work because the resultant benefits are diminished by the increased rate of tax per hour of work. However, some may argue that labour is fairly immobile, especially for those with fixed salaries, and thus it is hard for these employees to increase their hours worked regardless of tax incentives or disincentives. Nevertheless, through the rise of zero hour contracts in the UK, a growing number of individuals are highly responsive to tax changes. If income taxes fall they can increase their hours worked with relative ease to capitalise on these tax cuts, assuming the demand for and supply of labour are in equilibrium, and likewise if income taxes increase, many are able to reduce their hours equally quickly. Raising income tax rates consequently reduces the incentive of those in employment to work and drives both capital and labour out of the country.

At the G20 summit in June 2012, in response to President Francoise Holland’s proposals to impose a 75% tax rate on incomes over €1 million, David Cameron promised to “roll out the red carpet” to French business people fleeing to avoid these higher rates ^[11]. This reflects the disturbing weakness of income tax in that, due to the rise of globalisation, economies have become increasingly inter-connected and as a result the effectiveness of income tax falls as freedom of movement rises. As a consequence of loose capital controls, countries are racing to roll out this “red carpet” faster than their rivals, in pursuit of the wealthy demographic, all whilst sweeping the growing inequality beneath as they do so. The system of income tax is flawed across the globe. Whilst it may be untrue to present income taxes as ineffective in targeting the rich, the only effect of this targeting seems to be reward in place of punishment.

Inheritance taxes initially appear to offer some level of hope. These taxes do not embody the same negative economic connotations that income tax does. However, they are equally avoidable and thus are an equally feeble response to inequality. When his father Ian died, David Cameron received £300,000 in his will ^[12]. This was just below the maximum amount allowed, and so was exempt from inheritance tax. This sum has since increased to £325,000 under David Cameron himself. Following Ian Cameron’s death, the majority of the remainder of his estate passed to David’s mother tax-free, as they were married. David’s mother promptly gifted him £200,000, which, if she outlives this gift by seven years, will pass to David also tax-free. This act in itself does not constitute tax avoidance, but because David received this sum in order to equalise the amount he received from his father in comparison to his other siblings, this two-step process seems illogical. Negating the costs of inheritance tax, would it not have been far more practical for David to receive the entire sum in his father’s will? As a result of this two-stage process, if David’s mother lives seven more years, David will have avoided £70,000 of inheritance tax ^[12]. This exposes the inheritance tax system for what it is– crippled and corrupt. If society is so misaligned that the Prime Minister can avoid inheritance tax, and in the same breath reduce the amount of people forced to pay it ^[13], then this tax is unquestionably flawed.

Inheritance taxes are fundamentally unproductive, not only because they are so easily avoided, but also because they target so few. Inheritance tax is only paid if a person’s estate is worth more than £325,000 ^[13]. When the average inheritance in the UK is £63,279 ^[14], it is evident that this is a tax for only the wealthiest of the wealthy minority. Therefore inheritance taxes only serve to bring the wealthiest down to the levels of the still wealthy, yet do nothing to combat the growing divide between the rich few and the much poorer majority. Nevertheless, a reduced cap on inheritance taxes would be crucial in combating rising social injustice. An economy functions at its best when the most talented rise to the top, and inheritance rigs this process in favour of the rich, many of whom may not be the smartest or most suitable individuals for these positions. Inherited wealth facilitates opportunities for the rich that are out of reach for the rest of society. This is damaging to the economy, since restricting the jobs of innovators, leaders and entrepreneurs to the wealthy few effectively reduces the productive potential of society. When the best suited for these jobs are blindsided by the rich and well-connected, the economy suffers and inequality perpetuates.

The UK is on a trajectory to become the most unequal of the richest 25 countries in the world ^[4]. In their current state, it is evident that income and inheritance taxes are ineffective in slowing the growing tide of inequality that is flooding the globe. Other methods to restore equality are readily available but are all too often ignored, in favour of the prevailing free market ideologies adopted by governments worldwide. To tackle inequality we must first change our attitudes. It is no surprise that inequalities continue to rise, when in the UK, the Prime Minister presides over a cabinet containing more members of the 1% (those with a total household income of over £160,000 per year) than there have been in decades ^[4], when more boys from Eton go to Oxford and Cambridge than boys who are eligible for free school meals ^[15], and when one in seven members of the senior judiciary has been educated at one of just five different private schools ^[15]. It is apparent that elitism is embedded in our society. Having such little diversity at the top of society corrupts democracy.

The system we live in allows for vast and increasing disparities in wealth. This essay has shown that increasing income and inheritance taxes will do little to change that, and instead will cause more harm than good to those they intend to help. Without strict legislation the rich can easily avoid income tax, as they can afford the luxury of hiring lawyers and experts to do so. However, the poor do not have this same privilege and cannot afford to avoid these taxes. Thus income taxes fuel the rise of inequality rather than slowing it as intended. Inheritance taxes provide some benefit, but because of their ever-increasing ceiling, they do little to level the playing field for the next generation. Whilst inheritance taxes are effective in reducing the differences in wealth within the top percentiles, the differences between the top and the rest is largely unchanged. As a consequence, the rich can afford to build privilege upon privilege, wealth upon wealth, throughout the generations, whilst any small gain in income achieved by one generation of the less well off is immediately watered down by income and inheritance taxes, rendering its benefit to future generations largely imperceptible. The best education and the best jobs are restricted to those who can pay, and thus the cycle of inequality continues. The challenge to breaking this cycle lies in the fact that the political and business elite, who benefit from the status quo, are not answerable to the electorate as those that actually vote tend to be older and wealthier. The solution then is to engage more of the disenfranchised, the downtrodden and the underprivileged in the electoral process thus empowering us to make a change. Only then we can improve the life chances of those who currently cannot pay through better education and combatting the prevailing preference of employers for private over public schooled applicants, make the tax system fairer through stricter legislation, ensuring that we are all equally burdened by tax, not just those who cannot afford to avoid it, and we must alter our beliefs around wealth itself by not glorifying the wealthy but instead condemning them for their tax avoidance. But we must act quickly to avoid inequality snowballing further or else it will soon be clear that Kennedy’s time-old phrase must be updated for the 21^st century; the cheapest boats are sinking. A rising tide lifts only yachts.

Word Count: 2449

References:

[1] Harley Balzer (2015) 'Inequality: The Ukraine invasion and public opinion', Georgetown Journal of International Affairs,[Online]. Available at:http://journal.georgetown.edu/spotlight-on-16-1-inequality-the-ukraine-invasion-and-public-opinion/ (Accessed: 21st June 2016).

[2] Terry Macalister (2015) ' UK solar panel subsidy cuts branded 'huge and misguided'', The Guardian, 17th December

[3] Robert Looney (2005) 'Socio-Economic Strategies to Counter Islamic Extremism in Iraq', Calhoun: The NPS Institutional Archive,

[4] Danny Dorling (2015) Inequality and the 1%, 2nd edn., London: Verso.

[5] Robson, S.J., Laws, P. and Sullivan (2009) 'Adverse outcomes of labour in public and private hospitals in Australia: a population-based descriptive study', Med J Aust, 190(9), pp. 474-477.

[6] Ted Sorensen (2009) Counselor: A Life at the Edge of History, New York: HarperCollins.

[7] Juliette Garside (2015) Recession rich: Britain's wealthiest double net worth since crisis,Available at: https://www.theguardian.com/business/2015/apr/26/recession-rich-britains-wealthiest-double-net-worth-since-crisis (Accessed: 21st June 2016).

[8] John Doe (2016) 'The Revolution Will Be Digitized', The International Consortium of Investigative Journalists, [Online]. Available at: https://panamapapers.icij.org/20160506-john-doe-statement.html (Accessed: 21st June 2016).

[9] Fernando Blat and Jorge Gómez Sancha (2016) Offshore Leaks Database, Available at:https://offshoreleaks.icij.org/pages/about (Accessed: 21st June 2016).

[10] Vanessa Houlder (2016) UK tax gap climbs to £34 Billion, Available at:http://www.ft.com/cms/s/0/48d5a518-552a-11e4-b616-00144feab7de.html#axzz4BrPKKQgO (Accessed: 21st June 2016).

[11] Jonty Bloom (2012) Will the rich flee France's 75% tax rate?, Available at:http://www.bbc.com/news/business-19626188 (Accessed: 21st June 2016).

[12] Jolyon Maugham (2016) ' Did the Cameron family avoid inheritance tax?',Newstatesman, [Online]. Available at:http://www.newstatesman.com/politics/staggers/2016/04/did-cameron-family-avoid-inheritance-tax (Accessed: 21st June 2016).

[13] (2016) Inheritance Tax, Available at: https://www.gov.uk/inheritance-tax/overview(Accessed: 21st June 2016).

[14] Hayley Kirton (2016) UK adults expecting a big windfall from inheritance are set to be sorely disappointed, Available at: http://www.cityam.com/233720/uk-adults-expecting-a-big-windfall-from-inheritance-are-set-to-be-sorely-disappointed-with-one-in-ten-mistakenly-believing-that-the-payout-they-predict-will-fund-their-retirement (Accessed: 21st June 2016).

[15] Patrick Wintour (2014) Michael Gove attacks Conservatives' 'ridiculous' number of Old Etonians, Available at: http://www.theguardian.com/politics/2014/mar/15/michael-gove-old-etonians-conservative-david-cameron (Accessed: 21st June 2016).

[16] George Arnett (2014) Elitism in Britain - breakdown by profession, Available at:http://www.theguardian.com/news/datablog/2014/aug/28/elitism-in-britain-breakdown-by-profession (Accessed: 21st June 2016).

Gray's Economics

Thursday, 29 September 2016

Inflation

Saturday, 17 September 2016

Cherwell Economist Commended

Thursday, 15 September 2016

Inflation

Wednesday, 14 September 2016

Quantitative Skills