Can we reduce inequality without tackling the super-rich?
Yes, apparently. An interesting analysis by Lane Kenworthy (via Chris) suggests that redistributive government spending plays a much bigger role than progressive tax in reducing economic inequality.
He compares the Gini coefficient (measuring the degree of inequality) for household incomes in ten rich countries, but he does so both before and after tax, and both before and after government transfers. The amount of inequality reduction that the tax and redistribution systems achieve is shown here:
Two things are clear: income transfers reduce inequality by much more than tax does; and there is much more variation in the amount of equalisation that results from redistribution than in that from tax.
Lane also observes that the degree of inequality reduction does depend on the overall level of government spending, which of course depends strongly on the total tax take. These taxes need not be strongly progressive, though, in order for equalisation to take place.
I have two thoughts to add to this, by way of possible explanation.
First, increasing tax rates on the highest earners will only reduce their income by a proportion above the given threshold – it won’t put a cap on it. (And, as Vino says, the wealthy may be able to avoid many taxes, so reducing the scope for higher taxes on them to have real bite.) But redistributing to the poor guarantees their income won’t drop below the level of the benefits they receive. So the latter would seem likelier to have an effect on overall inequality.
Second, a recent Institute for Fiscal Studies study looked at high-income individuals in the UK. They found that the average income for all taxpayers (in 2004/05) was a little under £25,000. To get into the top 10% of earners, you needed to earn over £35,000. To get into the top 1%, you needed £100,000. And to get into the top 0.1%, you needed £351,000.
Clearly, the most striking inequalities are those appearing in the steepening curve at the top of the income scale; however, these inequalities involve a fairly small number of individuals.
To substantially cut inequality by taxing these people more, you’d need quite a large number of income tax bands at the top end of the income scale, each covering fewer and fewer people with higher and higher rates (a single high rate for the top 1% would ignore the huge inequalities within that group). Quite apart from whether this would be politically feasible or what economic effects it might have, it seems pretty impractical.
Conversely, though, to promote equalisation via benefits, you’d need to give the most to the poorest – which administratively (and politically) is much easier. There’s far less variation within the bottom 10% than there is in the top 10% – or even the top 1% – so precision targeting is far less of a problem.
What’s more, my own view is that the ‘poor people falling behind’ side of inequality is more troubling than the ‘rich people zooming ahead’ aspect. The Gini coefficient doesn’t distinguish between the two, but I think the former is obviously bad while the latter is very debatable.
(None of this is an argument against higher taxes on the very rich; it’s just to caution that this would not in itself reduce inequality by nearly as much as government redistribution could – whether the money comes from the top or across the board.)