Gareth Morgan

Gareth Morgan on the economy

Gareth Morgan and Susan Guthrie: Inequality will lead us to a grim future

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Wealth disparity threatens social fabric, write Gareth Morgan and Susan Guthrie.

Prime Minister John Key's newly elected government should be bold enough to confront the message from a December 5 OECD report. It confirms rising inequality in developed economies is a major problem that needs addressing urgently - and yes, New Zealand was included in the study and yes, we've had pretty much the greatest increase in inequality in the OECD in the last 30 years.

Further, the OECD data only relate to cash incomes (wages, profits for the self-employed, interest and so on).

If you were to do the study incorporating the non-cash returns to wealth you'd see the impact of the house price explosion in particular, opening the gap between those who do and those who do not own property.

That would reveal even greater widening of the disparities.

Should we care? Is the description of egalitarian New Zealand a hoary old chestnut nowadays and one we should just get over?

This is the debate New Zealanders need to have. Just what do we aspire to for the shape of our social fabric?

Should we ensure everyone has a dignified life - whether they're in paid work, involuntarily unemployed or voluntarily in unpaid work benefiting their families and communities?

Is there a minimum, unconditional level of income people in this relatively rich society should be entitled to?

For now, the low-paid, the involuntarily unemployed and the unpaid are left wallowing further and further behind those of us doing well in the market economy.

In time, increased polarisation of income and/or wealth leads to social disruption, political polarisation and paralysis, and eventual change, sometimes non-peaceful. Placed against the OECD's recommendations on what to do, the National Government's economic strategy is struggling - it's certainly insufficient.

This from OECD secretary-general Angel Gurria: "The social compact is starting to unravel in many countries. The benefits of economic growth DO NOT trickle down automatically, this study dispels that assumption. Greater inequality DOES NOT foster social mobility" (OECD's emphasis).

Markets won't naturally generate "trickle down" benefits. Well-designed curbs and checks are needed, supplemented by taxes that redistribute from the rich to the poor.

This was well known to the first modern "economist", the philosopher Adam Smith, writing in the 18th century as an unfettered industrial revolution made the poor poorer.

However, these basic truths about modern market economies have been forgotten, pushed aside by an ideological tsunami which began in the late 1970s and centred around the ideal of freedom.

The euphoria that accompanied this global movement affected not only politics (contributing to the break-up of the Soviet Union and the fall of the Berlin Wall) but economics - less regulation, lower taxes, less social support, increased globalisation and displacement of low and average wage jobs in developed economies.

In spectacular fashion, the global financial crisis has reminded us that freedom in economics will only get you so far; it needs to be strategically curbed by regulation and supported by effective redistribution. Freedom to lend certainly has come to an ignominious end.

It's worth looking at what the OECD sees as causing widening income inequality. While the evidence is mixed and difficult to unravel, they point to the role of technological change and globalisation in widening wage gaps (both make some skills and experience, especially low skills, obsolete and others highly sought-after), with the adverse effects on wages compounded where employee protection has been weakened.

Over time, tax and social assistance welfare policies have become less effective in ameliorating the effects of the widening wage gap on net income.

It's clear from the OECD report that piecemeal responses to single issues simply have not cut it as credible policy responses to this major economic challenge.

We may be mesmerised by the cheaper goods on offer, but they're expensive if your income falls faster.

In the words of the OECD: "Any policy strategy to reduce the growing divide between the rich and poor should rest on three main pillars: more intensive human capital investment; inclusive employment promotion; and well-designed tax/transfer redistribution policies".

National's election campaign emphasised investment in education. This is a necessary condition to prevent widening disparities but it needs to be focused correctly.

The OECD calls for increased access to tertiary education, for example. We recognise that getting early childhood, primary and secondary schooling right is important too. By comparison, National's charter school initiative is tinkering at the margins. Similarly, its proposal to push increasing numbers of Winz customers into (in practice, low-quality, insecure) jobs doesn't have the ring of strategic vision.

"Policies for more and better jobs are more important than ever," the OECD says. On tax, the message is clear: close down the loopholes.

"Tax reforms that increase average tax rates without raising marginal tax rates (for example, by scaling back tax reliefs) could enable greater redistribution without undue blunting of incentives."

In New Zealand's case, that means more than just looking at allowable tax deductions - it means taxing gains to wealth comprehensively, not just the cash income component.

Most countries in the OECD already have capital gains taxes and the more enlightened have wealth taxes (including, in some cases, taxes on owner-occupied homes). We essentially have neither.

We are unambiguously backward in this area. For New Zealand, the potential gains of real tax reform are enormous. They have not, as Finance Minister Bill English claims, been instigated. He has tinkered.

It's possible to design policies to address the great challenge posed by rising inequality. In the book The Big Kahuna, released in August, we detailed reforms to tax and welfare that would close glaring gaps in the tax system and thus create a better business and investment climate (a positive for sustainable job growth) and make human capital development more likely (an unconditional basic income or "UBI" of $11,000 net paid to everyone aged 18 and over, making it easier to up-skill and innovate).

By providing people with the flexibility and freedom to live their lives as they see fit (without interference or compulsion from Winz), the UBI would increase the resilience of our population in the face of the challenges posed by technological change and globalisation.

Who knows which skills will be obsolete in a few years? - certainly not the good folk at Winz.

By contrast, with access to unconditional support people would have the means and the freedom to extract a life they value, whatever the challenges they faced. That technological and global challenges will continue at a rapid pace seems inevitable. But it's not necessary for our society to be torn apart by them. People must have the flexibility to make changes and not be discouraged by the high effective marginal tax rates of targeted welfare.

What's possible is clear, and the opportunity is staring us in the face. What appears lacking is statesmanship - the leadership and political will to take New Zealand forward rather than stubbornly cling to and fine-tune a broken down system.

Present day strife in Europe is surely a clear lesson of what can happen when leaders don't step up to the podium.

Gareth Morgan and Susan Guthrie are the authors of The Big Kahuna - Turning Tax and Welfare in New Zealand on Its Head, available at garethmorganbooks.co.nz and all good bookstores.

- NZ Herald

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