Dissecting SA inequality leaves only one answer

THE World Economic Forum's latest Global Risk Report identifies severe income inequality as one of the 10 "global risks of highest concern in 2014". US President Barack Obama recently argued that growing income inequality and the restrictions it places on individuals' economic mobility is "the defining challenge of our time".

This was echoed in President Jacob Zuma's state of the nation address, which described the challenges of poverty, inequality and unemployment as "a central focus of all democratic administrations".

Devising effective policies to reduce inequality is difficult.

Laura Tyson, former chairwoman of the US president's Council of Economic Advisers, argues this is because the causes of inequality are more complicated than is generally believed.

She demonstrates this by comparing inequality in the US and Europe.

Inequality has been increasing in both areas for some time and inequality in the US is widely believed to be among the worst for developed countries.

Most critics of the US's brand of relatively free markets and minimal labour-market restrictions blame this higher inequality on unusually high wage disparities.

But, Tyson notes, the spread of incomes before taxes and social transfer payments to the poor is similar in the US to many developed countries — including countries such as Sweden and Norway, which are generally considered to be very egalitarian.

Tyson argues that the unusually high income inequality after tax in the US is not due to a tax system that favours the rich, as many critics allege.

Indeed, she notes, the US tax system is more progressive (taxes the rich more) than most Western European countries, Canada and Australia.

Tyson suggests that what makes US income "the most unequal among developed economies" are unusually small welfare payments to low-income earners. In more-equal countries in Europe, as well as in Canada and Australia, these transfer payments to the poor are funded not by higher taxes on the rich than in the US, but by much higher levels of value-added tax (VAT).

These findings contradict the common belief that higher VAT rates widen inequality because taxes on consumption purchases are regressive (they have a greater effect on the poor, whose basic purchases make up a larger proportion of their income).

 Not so, Tyson argues. It is exactly these regressive consumption taxes that have kept inequality lower in Europe than in the US, because they provide a larger income stream from which governments fund the much higher welfare payments that bridge the income divide between rich and poor.

Tyson notes that about 30% of the increase in US inequality after tax and after transfers over the past three decades can be attributed to reductions in the progressive nature of transfer payments and taxes.

Rising income disparities in the labour market — which are being experienced in other developed countries too — contributed the remainder of the increase.

Therefore, Tyson argues, two things need to happen in the US to combat growing inequality.

 First, the US needs a more progressive and redistributive tax and transfer system. But this is unlikely in the short term, she suggests, because the Republican Congress opposes increases in social welfare payments, as well as higher taxes on the wealthy.

Both the Republican and Democratic parties oppose a value-added tax. A European-style welfare system funded by VAT is therefore a nonstarter.

So the only solution, Tyson argues, is for the US to create more jobs to reduce unemployment among the poor, and to help to lift real wages.

Inequality in the labour market will also be reduced, she suggests, by an increase in the minimum wage, which has fallen in real terms. This last step has the best chance of success, she believes, as it enjoys support from Republican and Democrat voters.

This evidence from the US has important implications for SA, one of the most unequal countries in the world. Inequality has hardly changed since democracy, despite our now having one of the largest welfare systems in the developing world.

About 16-million South Africans, representing more than half of all households, receive welfare grants. Without these grants, the World Bank has argued, inequality in SA would have risen since 1994.

SA's ability to increase these grants is limited. Their present cost is R120bn (3.4% of gross domestic product — GDP).

A significant increase in payments would mean an unsustainable rise in the budget deficit (already more than 5% of GDP).

Nor does SA have the tax base for "taxing the rich" to generate the sums required. The Treasury's analysis shows that there are too few rich people in SA to make a meaningful difference to total government revenues, even if their tax contributions were ratcheted up significantly.

Increasing VAT is probably politically unacceptable, even if the revenues generated were ring-fenced for increased welfare payments.

Reducing inequality in SA thus boils down to jobs, as it does in the US.

We need more, better-paying jobs. And this depends on meaningful improvements in our education system, so that young South Africans can acquire the skills employers require.

Sadly, there is little evidence that this goal is being achieved at present for more than a small minority of school-leavers. Keeton is with the economics department at Rhodes University. 'What makes US income "the most unequal" are unusually small welfare payments to low-income earners' 

By Prof Gavin Keeton

Source: Business Day

Keeton is with the economics department at Rhodes University