Defusing the inequality time bomb

Good policy is good investment.

The only way to stop the inequality pandemic before it spreads further is through a radical reimagination of what constitutes good policies, addressing both structural and new inequalities embedded deep in our societies. Such policies may be politically and financially costly, but such costs paid now will be nothing compared to the costs to be exacted on future generations as social ills accrue over time.

The first step is to adopt good policies to end the pandemic: science-based, well-coordinated and effectively communicated policies tend to restore confidence, boost compliance and minimize contagion. The second is by extending the right amount of stimulus support to those who need it.

A new fiscal policy framework to meet the challenges of our time.

Beyond addressing the pandemic, the greatest investment we can make is by reconfiguring conventional fiscal policy and innovating for the times.

The power of fiscal policy cannot be understated: the International Monetary Fund (IMF)says fiscal policy, is responsible for reducing about a third of Gini coefficients— markers of market income inequality—although this is obviously less effective in developing economies.

Fiscal policy, however, can be a double-edged sword. Improperly wielded, the poor often end up suffering what the Argentinian economist Nora Lustig calls “fiscal impoverishment,” where the poor pay more in taxes than they receive in benefits, most of which will only be realized in a longer time horizon.

A rethink towards a more compassionate fiscal policy is thus needed as a prerequisite to a more inclusive form of capitalism. Below, I highlight some popular ideas that have emerged in the global conversation to combat inequality.

‘Redistributive policies’

First, governments need to close the yawning gap between the haves and have nots in what is called “redistributive policies.”

Chief among these would be making income taxes more progressive, which the IMF says has fallen sharply worldwide since the 1980s. Income taxes are even less progressive than each country’s law suggests, because the rich have more avenues for tax relief and avoidance, not to mention evasion.

US Treasury Secretary Janet Yellen decried the three decades virtually every economy spent racing to the bottom in terms of corporate taxation rates, and urged the Organization for Economic Cooperation and Development to conclude negotiations on a global minimum tax rate. This would allow economies to raise much needed fiscal resources they otherwise would not have raised for fear of appearing uncompetitive.

Any redistributive policy reform should therefore view improving tax compliance as a prerequisite. Capacitating tax authorities, especially with digital tools, will augur well toward increasing tax ratios.

Chief among this would be implementing a national digital ID system for both individuals and corporations, which doubles as a tax ID integrated with government payments platforms. Requiring unique digital ID credentials for all transactions above a certain amount will help mitigate tax evasion within and across borders.

Cap on cash transactions

Authorities may also consider a cap on cash transactions and encouraging the shift to digital transactions, which can help address corruption, money laundering, and tax evasion. Multilateral work on automatic exchange of tax information can also pin down the highly mobile nature of the global rich. Until then, wealth taxes will only be a pipe dream.

As globally synchronized quantitative easing floods the market with liquidity, governments must take pains to ensure the right amount of help is going to the right places: to those who need it, not those who can make the most financial gains from it. In this vein, fiscal authorities should consider bolstering levies on capital gains, especially if they are from speculative investments that have nothing to do with the real economy. Increasing value added taxes (VAT) can be considered, but ought to be targeted as consumption taxes tend to be regressive overall and disproportionately hit the poor’s wallets.

Higher state or inheritance taxes can rationalize the inter-generational transmission of obscene and unproductive wealth. More promising are real property taxes and taxes on idle land, as these recurring taxes are levied on an immobile base that would be harder to hide from authorities. Empirical evidence demonstrates that property taxes are less distortive and growth-friendly.

Long-return horizon

The IMF estimates the untapped revenue on property taxes for developing countries is up to 1 percent of gross domestic product (GDP) and 2 percent of GDP for advanced economies.

Such redistributive fiscal policies should be able to fund investments in health, education and infrastructure. However, these investments have a long-return horizon and would require the expansion of highly successful cash transfer programs in place in the Philippines and other developing countries.

These programs ought to be expanded to cover more families, but also strengthened with more rigorous targeting methodologies, the implementation of digital IDs and cashless payouts to prevent fraud and corruption, and the continued attachment of conditionalities like schooling and job retraining.

When enacted under vast government programs, redistributive fiscal policies are often viewed with suspicion, due to vulnerabilities to corruption and inefficient bureaucracy.

The idea of universal basic income (UBI) has gained newfound popularity in recent years. UBI provides universal and unconditional payments to every citizen to guarantee a basic standard of livelihood, assuring sustenance while leaving sufficient incentives to work and contribute positively to society. UBI is the simplest and fairest form of wealth redistribution: while even the rich receive UBI payments, they will more than compensate for it by the taxes they pay.

Some advocate a “basic income guarantee,” which effectively functions as a negative income tax with a permanent earnings floor, such that the taxman instead pays people living below the poverty line to make the difference. By building a floor underneath our society and automatically lifting those who fall through up towards a basic standard of living without conditions, security from poverty can be guaranteed as a basic human right and not a privilege.

Predistributive policies

Second, we must empower those who have the least to catch up with “predistributive policies” such that the need for redistributive policies grows less with time. This requires dramatic aforementioned investments in health, education, social services and infrastructure, sectors to which countries from Southeast Asia to even the United States have not paid due attention.

Policies that shape savings behavior and reduce the costs of asset-building are important. These include automatic enrollments in housing and retirement savings plans, including government mechanisms to match such contributions. Expanding affordable and quality access to finance can also boost home ownership rates and allow the poor to build intergenerational assets for the next generation.

Measures to narrow the digital divide and to keep pace with the 4th industrial revolution are critical. It is time to recognize internet connectivity as a basic human right and not an economic privilege, much like access to clean water and electricity. Accelerating digital infrastructure buildout should be a global development priority. Second, human capital investment through digital literacy, upskilling and expanding access to digital finance should be a priority and can be tagged onto conditional cash transfer programs.

To fund these investments, regional proposals to tax transactions and activities in the digital economy make sense. The World Bank recently said countries in Association of Southeast Asian-6 alone are losing $6 billion in revenues this year for simply failing to adapt VAT rules to the digital economy, whereas other countries have imposed levies ranging from 5-19 percent.

Taxing gains from online economic activities—especially from the large tech giants— ought to generate the resources required to narrow the digital divide and further expand connectivity for all, enlarging the digital economy pie overall.

Apprenticeships, earn-while-you-learn schemes and paid worker trainings have empirically been shown to drastically boost lifetime earnings of workers and improve productivity and competitiveness of economies. Workers in Europe who have completed an apprenticeship earn $300,000 more in their lifetime than peers who have not.

Meanwhile, employers who sponsor apprentices gain a ready pool of skilled workers, improve productivity and reduce employee turnover. For example, Canadian employers were able to recoup $1.47 in economic benefits for every $1 invested in apprenticeship training.

Structural adjustments

To fund both redistributive and predistributive policies, we need to make globally coordinated structural adjustments to tax policy, such that one country’s embrace of progressive taxation will not be seen as another’s strategic advantage, rendering fears of capital flight moot.

Adjustments to how incentive structures are built in our society are necessary for our grandchildren to have a chance at living in a world that no longer inherently engenders systemic inequalities.

This involves recasting economic paradigms that privilege wanton capital accumulation over actual sustainable stakeholder value creation, exemplified by how global capital favors winner-take-all monopolistic super-apps, excessive automation at the expense of labor, and cheap but carbon-intensive production. It also requires a critical examination of the current rules of the game that encourages the privatization of profit and socialization of harms and losses.

We, thus, ought to view inaction on climate change as an inter-generational injustice we are inflicting on future generations: an inequality of a magnitude like no other, putting the older generation’s lifestyle over the survival of the next. To address this head on is to fundamentally rethink our measurements of costs and value: integrating environmental impact to accounting systems and quantifying carbon consumption such that it becomes taxable.

Inequality as a social cost we incur as a debt

To this end, carbon taxation is a great structural adjustment to rebalance the scales, giving future generations a fairer shot at survival while curtailing the current generation’s ability to hoard wealth at the earth’s expense. Carbon taxes can broaden the tax base in lieu of existing taxes, and can be used to further fund redistributive and predistributive policies. Further, economists have found carbon taxes to be less regressive than feared, as access to carbon-emitting activities (e.g. car ownership) is heavily biased towards richer households, especially in highly unequal societies in emerging economies. This would also right an inequality among who benefits the most from low energy prices: according to IMF researchers, higher income groups receive around 90 percent of the economic benefits from cheap power.

We need to recognize worsening inequality as socialized costs we are incurring as debt for future generations to pay. Sooner or later, the debts will be due, and our kids and grandkids will have to foot this balloon payment dearly for our inaction.

We have the tools to reimagine a better world. We can start with a more compassionate fiscal policy as a way to reform capitalism toward a fairer and more inclusive future. INQ.

This article reflects the personal opinion of the author and does not reflect the official stand of the Management Association of the Philippines or MAP. The author is a Member of MAP, former finance secretary of the Philippines, Asia Fellow at the Milken Institute, and founding partner at Ikhlas Capital, a pan-ASEAN private equity growth platform.