Rising economic inequality will remain a pressing global problem in 2019 - it drags down growth and destabilises societies, putting low- to middle-income earners in increasingly precarious situations as fewer people control a growing share of income and wealth, writes Allianz Global Investors' Karl Happe.
While the biggest impact is on those on the lower end of the economic spectrum, economic inequality has ramifications for everyone. Government revenue streams are becoming stretched as tax coffers shrink and welfare expenses rise; this can reduce the level and quality of government services across the board. And, as the divide between the ‘haves' and ‘have-nots' expands, resurgent populism is threatening to create headwinds for economies and markets.
Given these tensions, couldn't we construct an economic model that maintains the benefits of capitalist production while limiting its tendency to create extreme inequality? There are numerous other ways I think we can progress how we are tackling inequality, which both incentivise investment while sharing the benefits of economic efficiency.
1. Build better incentives for work over welfare
Governments have long searched for ways to encourage lower-income workers to reduce their dependency on state support. Universal income is a popular proposal among academics, but a negative income tax for low-income employees may be a better solution. Similar to how the US earned-income credit functions, a negative income tax would "pay" workers whose incomes are under a certain level. It could effectively target subsidies at people who do not earn much but are economically active, and it could limit the negative incentives created by welfare systems that provide basic support in exchange for not working. For this idea to be effective and sustainable, however, careful thought must be given to the transition between negative tax rates and positive ones.
2. Balance the taxation of labour and capital
Automation and artificial intelligence have already displaced or eliminated millions of jobs around the world. Tax codes can make matters worse by taxing corporate earnings from automated processes at a lower rate than earnings from employing humans.
This could be addressed by levelling out tax rates on employment income with tax rates on investment income. Moreover, adjusting capital gains for inflation so only real gains are taxed would provide a greater incentive to invest for the longer term. These ideas might reduce efforts to reclassify employment income as investment income - a technique that many hedge funds use to lower tax bills for their employees. However, this also reduces revenue streams for governments.
3. Design more progressive tax wedges
In many countries, social security (or payroll) taxes are taken out of earnings only up to a certain level. This can create unfair "tax wedges" -in other words, a higher sum of income and social security taxes for low- and middle-income earners than for higher-income earners. By making tax wedges more progressive - or at least not regressive - governments could reduce incentives for individuals to either not work, or to limit how much they work.