Read Vince Cable‘s full speech to the Resolution Foundation on Inequality here:
Inequality – Resolution Foundation
Politicians talk at length about fairness and unfairness. Verbal confetti. Bland. Something almost everyone can relate to emotionally. And it can be defined in so many different ways that it can be applied in almost every situation, for about every audience. Inequality narrows the subject down a bit but, again, has a wide range of definitions and meanings.
Putting aside the health warnings and the academic qualifications there is however, in the UK in 2017, something stirring around the idea of inequality: something new and worrying. It starts from the observation, or the belief, that inequalities of income, wealth and opportunity, between classes, regions and generations, are getting worse; that Britain is becoming relatively as well as absolutely unequal when we look at comparable countries, especially in Europe; and that this inequality is not merely offensive to the sensibilities of progressive minded folk but is doing serious damage to the wider society and economy.
Sometimes an event crystallises this feeling. The Grenfell Tower disaster wasn’t just a horrific accident with a large loss of life but illustrates in a graphic way that relatively poor people were not listened to by those in authority and attracted a casual approach to life threatening risk. And close by geographically, but light years away socially and economically, lived London’s super-rich.
What motivates me personally and politically is the way this this new Britain contrasts with the more egalitarian culture and mobile society that I grew up with: parents who progressed in 20 years from being factory workers living in a terraced house with an outside loo to being part of the professional class living in a detached house; from parents who left school at 15 progressing though ‘night school’ to a son at an elite university. There were of course ‘posh’ people in post-war Britain but they were few and largely inconspicuous; and there were poor people on the council estates but they were distant relatives or friends and we played and watched football together. A provincial British city, even today, does not have the jarring contrasts of London; but my sense is that even there, big differences in living standards and opportunities have opened up.
It is possible to argue interminably about definitions. There are however some trends that are strong.
First, in the UK, gross real earnings of the top 10% of full-time workers doubled between 1978 and 2008; the median grew by 60% and the lowest 10% by 25%. After the financial crisis, overall gross real earnings fell by 8% over the next five years; have barely recovered to the 2008 level; and are now falling again. The combination of absolute decline following generations of widening inequality explains much of the current sense of malaise and unfairness.
Second, the standard measure of income inequality. The Gini coefficient, shows Britain’s post-tax inequality, rising strongly in the 1980’s (from 28% in 1978 to 41% in 1990) though it has stabilised a little since (to around 37%). But from having been one of the more egalitarian developed countries, the UK is now one of the least, well behind Scandinavia and also behind Germany and France. The Scandinavian comparison is telling in that, pre-tax incomes there, are significantly more unequal than in the UK but, after tax and benefits much less. We are less unequal than the US, post-Communist Russia, Mexico, Brazil and South Africa though that isn’t a very high bar.
Third, and in common with other countries, there has been an extraordinary concentration of rewards in the hands of the top 1%, and within that group, the top 0.10%. The top 1% consists of roughly half a million individuals with an income of just over £150,000: mostly middle aged men in financial services and senior management or the upper reaches of professions like law and medicine. The super-rich – the 0.10%- are roughly 50,000 people earning £1 million or more a year. This group consists on the one hand of people with unique talents in sport and entertainment and on the other of business executives and investment bankers on large bonuses. Public attitudes seem to differ considerably as between those groups which suggests that the issue is not inequality as such as the route to it. When Arsenal or Tottenham football players complain about being underpaid on £200,000 a week the fans’ reaction is less one of anger at the players as at their managers for risking losing them. I have never detected any such appreciation of top business executives (which had a collective pay rise of 440% between 1998 and 2013, when the FTSE index rose by only 11%). Or for the bankers fretting about a shrinking bonus pool.
Fourth, wealth inequality is greater than for incomes and is growing; a trend apparent in almost all western economies, as Piketty, Atkinson and others have shown. In the absence of compensatiing wealth taxation, high earners can turn their high income into assets and the value of assets can be compounded through investment (and passed on as inheritance)
In the UK, what is particularly striking about wealth inequality is the impact on different generations. The age group 26 to 44 have estimated average net assets of around £75,000; under 25 year olds, no net assets; and 55 to 64 year olds net assets of around £430,000. Rising house prices relative to earnings boost the wealth of older owner occupiers, unencumbered by mortgages and exclude younger people from home ownership. For low to middle income households under 35 the population of home owners has fallen over 20 years from 60% to 25%. The position is worsening.
Fifth, and lastly, social mobility is declining. My parents’ experience of economic and social mobility would be very difficult to achieve today. The housing market no longer acts as an escalator for the growing numbers who cannot get on it. There is also high correlation between educational attainment, especially at elite institutions, and the education attainment of the next generation. My three children followed me to Oxbridge and my grandchildren look as if they are headed the same way: no surprise. And, in the OECD, the UK (like the USA) is one of the worst performers in terms of social mobility with an exceptionally large wage premium for children growing up in a well-educated family (and, conversely, a wage penalty for those from less educated families).
Measures like the pupil premium, which Lib Dems introduced during the Coalition Government, are helping to narrow the attainment gap but we are far from being able to say that no one need worry about inequality because Britain has compensating social mobility. It doesn’t.
Does Inequality Matter?
If inequality is growing and social mobility is declining, why do we put up with it? There is an obvious, if cynical, explanation that the wealthier, usually older, people are better at defending their interest than the poor: more conscientious and motivated voters; more articulate; better connected.
The one serious argument put up in support of inequality is that it is a necessary evil: a concomitant of a dynamic, capitalist, economy in which there must be incentives to innovate, invest, save and work. Yet there is no obvious explanation as to why the top 1%, and especially the top 0.1%, have accelerated away, since Western economic performance has deteriorated in the last decade, not improved. Moreover, this phenomenon of widening inequality (with indifferent economic performance) is largely a US-UK phenomenon with nothing like the same story in Germany, Scandinavia and Canada (or France and Japan, though they have had economic difficulties).
Indeed, there is quite a lot of cross-country evidence that too much inequality can harm economic performance and redistributive politics can do good, or at least no harm. Studies suggest that higher levels of inequality are associated with unproductive, ‘rent-seeking’, activity; contribute to financial instability; feed ‘asset bubbles’ rather than productive investment; weaken demand leading to a growing dependence on personal debt to sustain consumption; and lead to underinvestment in human resources through education and health.
What is to be Done?
The clear conclusion is that inequality as an issue should no longer be seen as the presence of idealists and socialists who yearn for a better world. Too much inequality is bad for all of us. Put simply, growing inequality is linked to poor economic performance, greater economic instability, more social tension, insecurity and unhappiness. There should be a broad basis of support for measures which are seen to reduce inequality and contribute to a reduction in economic and social ills.
A less comfortable conclusion is that many of the inequalities of wealth and opportunities are embedded in a highly dysfunctional market for property and land. Britain is a country where wealth accumulation is achieved by requiring property (or land) and watching the price go up rather than by technological innovation and developing overseas markets. Bank financing is heavily skewed to reinforce that bias. For the fortunate segment of the population which owns their own home property isn’t just a home but an investment, a pension, a mark of status. Tackling inequality in this context is, therefore, fraught with political difficulty.
It is also the case that inequality is multi-dimensional, not just about income and assets. There are inequalities of geography, ethnicity, gender and generation. Inequality and social immobility involves complex issue around parenting, early years’ education, post-16 education and training, health, access to housing and employment. I will attempt to deal in more depth with some of these issues on future occasions but I will stick here with the more tangible inequalities of income and wealth.
One question to be addressed is whether these inequalities should be addressed at source – pre-distribution – or by mitigating the impact of market driven inequalities through progressive taxation. The socialist (and populist) traditions in politics have tended to concentrate on the former; more social democratic, and liberal, tradition – such as mine – on the latter. There is currently some common ground amongst Trump supporters in the USA and the radical left and between the National Front in France and the far left to blame inequality on ‘globalisation’ and (according to taste) on trade and immigration or (in Brexit Britain) on European integration There is some, albeit rather weak, evidence that unskilled wages have been negatively affected by openness to trade and/or migration. But the costs of economic nationalism far outweigh the benefits; technology is a far more potent driver of these inequalities; and there are fiscal and other ways of offsetting them.
But there are aspects of pre-distribution which do have to be addressed:
I spent much time in government reforming corporate governance around executive pay and the evidence is that the empowering shareholders, and greater transparency, has moderated the behaviour of FTSE 100 chief executives, though not to a radical degree. I support measures to toughen up the regime by publishing pay ratios and shareholders’ voting data. The current government’s proposals, last week, are useful but modest tweaks to the reforms we introduced in 2013. However Institutional shareholders do not have high levels of motivation to temper egregious executive pay since they are often in receipt of very large remuneration themselves. But unless they do there will be a demand for far more intrusive interventions.
Top pay has symbolic importance far in excess of its actual contribution to the distribution of income. It signifies fairness or the opposite. The pay of vice-chancellors for example has become the causus belli for those demanding fundamental reform of university finance and tuition fees and, in particular, bringing universities firmly within the control of the state. In practice, university vice chancellors’ pay will account for only a tiny fraction of university teaching and administrative costs. But unless those at the top in business or public institutions learn to exercise restraint, these will build up an irresistible demand for detailed state control of pay or for prohibitive taxation.
The same is true in reverse in relation to the exploration of low paid labour. The minimum wage system, with a minimum wage set on the advice of the Low Pay Commission, had – with hindsight – a broadly beneficial effect of lifting wages without negatively impacting on employment. We are yet to see the full impact of a more politicised National Living Wage driven by ministers rather than in response to Commission advice. There are potentially negative consequences for skill development of squeezing the differential between minimum and average earnings; and a system which rewards households with multiple earners rather than single earner, poor, families has perverse consequences. But, overall, the minimum wage system has had benign effects, raising wages but not at the expense of employment and is an important fixture provided it remains subject to evidence based disciplines.
Distribution and Tax
Progressive income tax is often seen as the most politically appealing route to greater equality. The British Left remains very attracted to very high marginal tax rates on the rich variously defined. Yet the experience of the countries, including those in more egalitarian Scandinavia, is that marginal tax rates of anything much above 50% are counterproductive and lead to rapidly diminishing returns. Sweden has top tax rates of 60% but is now an exception. There is greater merit in trying to eliminate the large opportunities which exist for legal tax avoidance and arbitrage: cutting the differential between capital gains and income tax; equalising rates of tax relief on pension contributions between high and low earners, and ending the remaining tax privileges of those who are resident but not domiciled in the UK. A big cultural shift could be accomplished if the UK were to move to the Scandinavian model of full public disclosure of tax returns.
Incentives created by the income tax system matter just as much as the bottom end of the tax range as the top since there are already steep rates of benefit withdrawal which create a disincentive to work or seek overtime. The Lib Dem coalition made considerable progress lifting the income tax threshold for low earners but extending it further is an expensive tax reform which benefits high as well as low income tax payers. National insurance employee contributions kick in at much lower incomes and future tax cutting policies should concentrate on lifting the NIC’s threshold. The whole national insurance system has long since departed from its original purpose of financing the welfare state and creates numerous tax anomalies (the shifting boundary between employed and self-employed; the exemption of working pensioners). It would make more sense to integrate fully the income tax and employee national insurance systems recognising however that there are serious ‘cliff edge’ problems and unintended consequences for which careful planning would be needed.
It is widely believed on the Left that the root cause of inequality is a shift from wages to profit: a modern version of standard Marxist theory. In the UK, wages (widely defined to include all earnings, including earnings and bonuses of the highly paid) as a share of national income fell from 65% in 1975 to around 50% in the early 1990’s as a consequence of policy changes – the Thatcher era. But it recovered to 54% and has remained largely unchanged since, so hardly an immediate source of grievance. Nonetheless, ideas like worker share ownership ensure that workers benefit directly from larger profit margins and are very much to be encouraged.
The left has often jumped to the conclusion that the way to rectify this measure is to tax profitable business – raising corporation tax – or taxing profitable business activities – like the proposed tax on financial transactions. There is actually a good, pragmatic basis for reversing competitive corporation tax cuts (my party argues for keeping the CT rate at 20%) and also for reversing the exemption of financial services from taxes like VAT. But this has nothing to do with inequality. Businesses are merely legal entities and business taxes are passed on to consumer or back to wage earners.
If Britain is to become a more equal society, a serious review is needed of the set of taxes which are there to mitigate the sharp, jarring, differences brought about by asset inflation and unearned income. We must tax wealth effectively.
The present system is a patchwork of different taxes, all flawed in different ways and full of loopholes. Inheritance tax allowances have grown more generous reflecting house price inflation and there is considerable scope for avoidance through gift before death. Capital gains tax too has a plethora of reliefs. Britain has no tax on property values as such and council tax serves as a very unsatisfactory substitute based on ancient property values and not proportional to property or land values. One could add various wealth related charges like stamp duty. Together these taxes raise around £50 bn a year of which half is council tax: representing, overall, half of one percent of household net wealth.
I do not doubt that unravelling this complex and uncoordinated system by reforming the taxes individually or through a unitary wealth tax would be a major undertaking.
One relatively straightforward way of reforming the system would be to reform council tax by creating more bands and making the tax rate proportional to property value. Low bands would pay less; high bands more. In the long term there is scope for more radical reforms shifting the tax base to land so as not to disincentivise property improvement and building.
It is also necessary to ensure that there is effective taxation of inherited wealth. Inheritance is a major factor perpetuating inequality of wealth and inhibiting social mobility. That is why genuine meritocrats – like Bill Gates for example – argue for aggressive taxation of inheritance. In fact, policy in the UK has moved in the opposite direction.
Wealth taxation should not be anti-business. Well designed wealth taxes encourage long term investment and entrepreneurship while discouraging speculation, inheritance and passive asset ownership. On Monday this week the influential entrepreneur Luke Jphnson argued for taxing property more and income less. Nor should wealth taxation be seen as a cash cow for government; I would like to see increased wealth taxation channelled back, perhaps hypothecated, in the form of learning accounts for young people.
I have no doubt that tackling the inequality of wealth, and particularly property, is deeply uncomfortable in a country where property ownership has almost religious significance. But, unless we are willing to do so, rhetoric about unfairness will become a rapidly devaluing currency.
Income and wealth inequality is a continuing social and economic weakness in the UK. It undermines any attempt to build a national consensus on the future of the country and helps to explain why the country voted Brexit (though it is likely that their own position will be worse as a result).
My party and I want to major on the issue of how to reduce inequality. Our 2017 manifesto was judged the most redistributive of the three by the IFS. There is a Coalition legacy of measures like the Pupil Premium, improving minimum wage enforcement and disciplines on executive pay, and seeking to lift low earners out of tax . This will be a theme of my leadership.