Rich-Poor Gulf Hard to Measure

Susan GuthrieTax and Welfare

The gap between rich and poor is an important issue that rarely gets discussed by our economic mandarins. Yes, we’re told (relentlessly) whether or not economic activity is increasing, and how the risks to that activity are large and looming, but there is very little discussion of how the spoils of all that effort, or the burdens of downturns, are divided among us. Yet, as the IMF recognised in a report last year (Leveraging Inequality, December 2010), increasing inequality can destabilise economies – indeed the IMF believes a failure to contain inequality has contributed to the global financial crisis:

“Restoring equality by redistributing income from the rich to the poor would not only please the Robin Hoods of the world, but could also help save the global economy from another major crisis.”

So it was a welcome change to learn that Prime Minister John Key and Labour leader Phil Goff finally aired the issue in Parliament last week. However, they were boxing in a fog.

The truth is, we really don’t know whether the gap between those who have plenty of resources available to them (annual cash income and, more importantly, available wealth) and those who don’t has been rising or not, or by how much. For a start, we haven’t measured household wealth. Typically, we’ve only had taxable income to go on and that is a poor indicator of someone’s resources, especially when you have a tax regime that encourages the wealthy to minimise taxable income.

Take the share of total taxable income commandeered by the top 1 per cent of the population. It looks as if the period from World War II to the mid-1980s was a golden era of improving equality. The top 1 per cent of personal taxpayers had around 15 per cent of all taxable income during the 1920s and 1930s and this had fallen to 5.5 per cent by the early 1980s. However in the 1920s the top tax rate was about 23 per cent while during the late 1930s it rose sharply and by 1940 was well over 60 per cent where it remained (more or less) until the late 1980s. It should be no surprise that fewer people declared huge incomes during this period – big earners had every incentive to take their income in non-taxable forms (meaning the estimated gap between the haves and have-nots was probably understated).

From the late 1980s, high earners began to race ahead, with the top 1 per cent again earning 14 per cent of all income by 1999. It may well be that globalisation of the executive recruitment market, financial liberalisation and changes to the public sector led to accelerating executive packages. But isn’t it also possible that the radical lowering of the top tax rate in 1989 to 33 per cent (when it had been over 60 per cent just a few years earlier) – a level that was retained until 2001 – led to high incomes again being reported to the IRD? The benefits of avoiding tax had fallen enormously. The reported share began to fall again once Michael Cullen, in an outburst of populist symbolism, raised the top tax rate to 39 per cent in 2001.

More recently, surveys have been used to measure household income. But these exclude income earned and retained within family trusts (income distributed by family trusts to trust beneficiaries is included). In 2009, that meant income equal to around 12 per cent of the total wage bill of the economy was not captured in the surveys. This wouldn’t matter too much if the same proportion of income was retained within trusts every year – the survey trends would be accurate. But when the top personal tax rate increased to 39 per cent in 2001 while the trust rate stayed at 33 per cent, the proportion of trust income that wasn’t distributed began to rise strongly. The pressure to retain income within trusts increased further when Working for Families was introduced in 2004. Undistributed trust income was ignored when determining eligibility for the Working for Families tax credits (changes in the last Budget mean trust income will now be a factor affecting eligibility for the tax credits).

So heavy scepticism is warranted about claims the income gap has narrowed since 2004. Sure, Working for Families successfully boosted the income of low-wage families, but it also prompted migration of some high incomes into trusts (and other vehicles) and out of official statistics (and possibly out of the tax net). Can anyone really claim the true gap between the haves and have-nots narrowed at all? Until we start measuring households’ wealth (held in their own name and in their family trusts) as well as the income they receive, we won’t know how large the divide really is. And the debate between the Keys and Goffs of this world on this issue will be pointless.

The distribution of resources (income and wealth) in our community is hugely important. If we didn’t know that already, we now have confirmation from the IMF. We appear to want to ensure the gap doesn’t get too wide – otherwise why do we persist with progressive tax rates and means-testing cash transfers such as Working for Families? However current policies (tax, Work and Income benefits, Working for Families, NZ Super and other transfers) are a very poor quality attempt at redistributing. They leave considerable amounts of wealth untaxed and redistribute cash on an arbitrary but populist basis. Current policies arguably exacerbate differences in market incomes and goodness knows what they do to wealth distribution. A comprehensive, principle-based redesign of policy is long overdue.

Rich-Poor Gulf Hard to Measure was last modified: December 15th, 2015 by Susan Guthrie
About the Author

Susan Guthrie

Susan is an economist who, prior to joining the Morgan Foundation in 2010, held various private and public sector roles. She has worked for the Reserve Bank of New Zealand and the NZ Treasury, as an international economist in the financial sector in New Zealand and Hong Kong, and as an advocate for consumer rights. In 2011 she co-authored with Gareth Morgan ‘The Big Kahuna’, a book advocating tax and welfare reform for New Zealand and in 2014 she co-authored with Gareth ‘Are we there yet? the future of the Treaty of Waitangi’.