Thematic BlogSpot - Inequality: what role for policymakers?
While inequality is coming to the fore of the policy debate, as discussed in our previous BS, policy responses differ depend on the definition of inequality, on institutions or economists, or what economists think is the driver of global inequality—leaving a vacuum as to what policies to actually implement according to Mohamed A. El-Erian.
Do central banks have a role to play in reducing inequality?
A recent article written by Olivier Coibion, Yuriy Gorodnichenko, Lorenz Kueng, and John Silvia demonstrates that between 1980 and 2008, the Fed’s conventional expansionary monetary policy led to widening the gap between rich and poor. While Joseph Stiglitz argues that the Fed should deepen its intervention on the financial regulation side to address loan discrimination, Michael Strain fears that the Fed will become even more dependent on the Congress and that a further intervention will create confusion for the markets.
Strengthening the redistributive function of fiscal policy.
Concerning taxation, Guner, Lopez and Ventura show that the US has still additional room for income tax hike contrarily to some European countries. Based on the assumption of high non-permanent individual productivity for top earners, Kindermann and Krueger conclude that high marginal tax rate on the top 1% earners is better for society. Additional state revenue generated could thus be used to decrease marginal taxation on low-income individuals. This policy proposal is supported by Piketty who identifies an additional condition to prevent tax avoidance: closing loopholes. However, it can stimulate rent-seeking behaviours from the top 1%. Saez and Zucman suggest implementing progressive wealth taxes and estate taxation in order to lower wealth concentration. However, the IMF warns about the distortionary effects of capital tax on savings and investment and highlights the difficulty to tax a mobile capital. The solution could rely in Piketty’s international capital tax to avoid fiscal competition between states and prevent tax avoidances. But he admits that this tax flat “would require a very high and no doubt unrealistic level of international cooperation”. An OECD report states that harmonizing capital taxation between different types of capital should be the priority on the short run. On the expenditure side, the IMF recommends increasing the retirement age, linking pension eligibility to years of contribution and incorporating pensions into a progressive tax. A progressive reduction of benefits should prevent old-age poverty. Means testing and conditioning of child benefits plus the reduction of the maximum duration of paid parental leave benefits should encourage women to return more quickly to their work after they give birth. These measures together address various types of inequalities. A question is whether redistributive fiscal policies can hinder economic performance. According to Guner, Lopez and Ventura, shifting the tax burden on top earners would not raise much state revenue because labour supply, capital stock and aggregate output will decrease. Maybe as Stiglitz points out, GDP is not sufficient to measure economic performance, because it does not take into account the sustainability and the quality of growth including increasing in living standards through lifetime.
Are structural reforms the magic wand?
Labor market reforms: providing better career prospects and an exit gate from vulnerability. The OECD and the IMF promote labor market reforms to increase employment, notably by targeting the youth, migrants and women participation, the most vulnerable and less integrated groups on the job market. Earned Income Tax Credit and in-work benefits promoted by the IMF should encourage labor force participation.
Education and Health: tools to reduce inequality in the long run. OECD recommendations are centered on improving quality and reach in education with the aim to address inequalities of opportunities in the long run. These proposals include increasing upper secondary attainment, incentives to pursue tertiary education based on reducing tuition fees and promoting equity in early childhood by formal care and education. Once the transition to work is achieved, the OECD encourages governments to implement incentives for employees and employers to pursue investments in human capital.
Besides, promoting and increasing access to public services such as Health by universal health coverage will provide additional income for the have-nots and will increase intergenerational mobility. The OECD (report) underlines that if the previous reforms were implemented we might rely less on fiscal policies in the future.
To conclude, a mix of all the above policies is needed because all the dimensions of inequality are intertwined (see graph above). Relying exclusively on fiscal reforms won’t be financially sustainable in the long run. Some pro-policies have ambiguous effects on inequalities and imply trade-offs. Hence, as said by Benedict Clements, David Coady, Ruud de Mooij, Sanjeev Gupta, policymakers should take into account individual preferences and carefully design the policy mix to prevent those trade-offs in times of slow and unequal recovery.
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