If politicians are serious about tackling inequality they need to properly overhaul the tax system – here’s how

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Inequality has shot to the top of the agenda across the political spectrum. Politicians, activists, and even billionaires increasingly call for more radical measures to tackle the problem.

Britain’s Conservative government proclaimed the end to austerity in its September spending review. Its party conference also discussed providing more equal access to education and social services, along with plans to increase the minimum wage.

Meanwhile, the Labour party vouched to raise taxes on corporate profits, incomes of the richest earners, and transactions in the financial sector. At its recent party conference, it announced an expansive programme of free public services.

Until recently, the opposite kind of measures were a priority. Lowering taxes for both business and the wealthy, and rolling back public spending in favour of free market competition were seen as a lasting legacy of Ronald Reagan and Margaret Thatcher.

Some argue that inequality is necessary to give people incentives to compete and innovate, ultimately making the economic pie bigger for everyone. Thatcher halved the tax rate on highest incomes in the UK from 80% to 40%, where it has hovered since. And public spending as a proportion of UK GDP fell from nearly 50% in the mid-1970s to less than 40% in the early 2000s.

But at the same time inequality levels have become untenable. In the UK, the richest 1% owned 20% of all personal wealth in 2012 and earned nearly 12% of pre-tax national income in 2016. The numbers are even higher in the US, and are also increasing globally, including in India and China.

Average economic growth may be ticking upwards but there are too many visible disparities in societies where record levels of homelessness co-exist with a high and rising number of empty homes.

Addressing the problem

More information on the scale of inequality – and its consequences – has put pressure on politicians to address the problem. In fact, elements of both the Labour and Conservative parties’ proposals are needed. Complementing tax increases with higher public spending has more potential to successfully reduce inequality in the long-run than either of these policies alone.

Advocates of higher taxes note that resources accumulated by the rich are largely saved and invested in personal assets such as luxury houses or yachts rather than reinvested in innovation and jobs. Similarly, an increasing portion of corporate profits is not spent on production: productive investment has withered despite corporations building up record cash reserves.

The poorest earners bear a greater tax burden than the rich. So there is merit – and scope – to increase rates on the highest earners to redistribute economic resources more fairly.

Taxing wealth not income

But this is only part of the solution. Many economists, inspired by Thomas Piketty’s seminal work Capital, argue for explicit taxes on wealth. As the billionaire Bill Gates has pointed out, most resources of the rich are contained in their assets rather than in their income streams, and so taxing wealth directly would be more effective in curbing inequality.

It is also vital to tighten the screws on the way transfers of wealth are taxed. For instance, inheritance taxes are in desperate need of reform, as they currently raise notoriously low amounts of revenue.

Another proposal for taxing wealth transfers targets the financial sector. Short-term speculative trading between financial institutions was responsible for triggering the 2007-08 financial crisis. Taxing financial transactions could reduce the instability that results from risky financial activity by increasing the costs of speculation. This kind of tax could also lower inequality by making risky financial instruments less desirable and decreasing the potential gains available to financial elites.

Preventing inequality from the get-go

Tax reform is much needed. But even with strong political will, taxes tend to be avoided and evaded through legal and illegal means respectively. A more comprehensive strategy is required, focused on “predistribution” – this means preventing inequalities from developing in the first place.

Current proposals for predistribution policies rightly target housing – one of the biggest financial concerns for people. Home ownership gives a boost to household wealth, but it may also make it more unstable if backed by large mortgage debt.

The 2007-08 crisis showed the pitfalls of relying on private markets to supply housing, with many families experiencing big losses as house prices plummeted. Even programmes such as Help to Buy – which makes it cheaper for first-time buyers to put down a deposit on a home – relies on private developers to supply housing and has been widely criticised for fuelling inequality.

Housing has to be a focus. Shutterstock

In a recent paper, I found that people do not benefit equally from holding assets such as housing supplied by private providers. Women, people of colour, millennials and low-income families experience lower improvements in their financial well-being from holding wealth compared to others. This is because they are more financially vulnerable and their access to wealth, as well as the way that the value of this wealth changes over time, is not just down to individual decisions but is largely influenced by economic policy and the way in which financial markets operate. So a careful strategy of public provision of key assets is needed to support more vulnerable people and reduce inequality.

Politicians have started to notice the importance of these types of policies. The Labour party has committed to build a million new homes and regulate the private rental market if elected. In the US, Bernie Sanders, a 2020 US presidential election hopeful, is promising “housing for all”, and similar initiatives have been mentioned by other candidates.

One initiative alone won’t fix inequality – a large overhaul is needed. A successful strategy should be comprehensive, complementing tax reform with predistribution policies. There are many potential difficulties to consider, but with political will in place, the time is ripe for systemic change.