Alexander Bowen: We have entered the age of the inequality-industrial complex

Alexander Bowen is a trainee economist based in Belgium, specialising in public policy assessment, and a policy fellow at a British think tank.

The state causes inequality.

Now it might sound like a trite statement; the kind of quasi-edgy comment made at an overly intoxicated Hayek Society meeting or manifested by a talking head for a very deep and meaningful daytime television programme, the kind of show that could not in any sense be described as political-slop, but it is a statement that is mathematically and provably correct and, with the Greens on the march and Labour backbenchers demanding the do-something lever be pulled, understanding why has never been more important.

A year ago, I wrote on why Gary’s Economics and the ever trendy wealth tax proposal wouldn’t work – that a 2 per cent tax transformed from stock to flow and combined with inheritance and capital gains becomes a 100 per cent tax – and whilst it was correct there was a fundamental error in that article and it was a simple error too. Accepting the premise – arguing on their ground and on their terms. Here then, I’ll do my bit to correct it.

“The state causes inequality” is a statement that feels unintuitive, perhaps not here, but certainly to most people but again it is a statement that is correct and it is correct for three simple reasons – planning regulation, providing public pensions, and giving out benefits. Each are measures that superficially ought to reduce inequality but, using the data of wealth tax doyen Piketty himself, do the exact opposite.

Let’s start with giving out benefits.

Universal Credit, Jobseeker’s Allowance, Disability Living Allowance, take your pick. These are all measures that to any rational person reduce inequality – they provide, more or less, direct financial support to people who typically have and earn little. Anyone with eyes can see that, yet none are so blind as those who refuse to see, and to the ‘democratic socialist’ inequality economist they do the opposite – they are the vector by which inequality emerges.

I mean this on a quite literal methodological level too. Again, and again, and again, press release after press release has been issued by one think tank or another arguing that the UK, thanks to VAT, or Council Tax, or National Insurance Contributions, or practically any tax other than income, has a flat tax system. It’s a claim that originates again with Piketty and that is only made possible with a pretty technical trick but one that is nonetheless still a trick – counting the tax on spending that welfare makes possible without counting the welfare.

In essence overstating the numerator and understating the denominator.

Take a fictional person that receives £1,000 in benefits and £1,000 in income – paying let’s say a 10 per cent income tax and spending it all thus paying VAT at let’s say 20%. What tax rate do they pay? There’s approach one that says the person pays £100 in income tax and £380 in VAT which, divided by their benefits and their income, is a 24 per cent tax rate. Then there’s approach two – removing benefits from the system entirely – leaving the person to pay £100 in income tax and £180 in VAT for a 28 per cent tax rate. Last but not least there’s the inequality economists approach – taking the £100 in income tax and £380 in VAT and dividing it only by the £1000 in income earned, yielding a 48 per cent tax rate.

What this logic produces then is a doom spiral – using data showing ‘taxes aren’t progressive’ you justify higher benefits, and in turn those higher benefits have the effect of making taxes seem even less progressive, justifying higher benefits that have the effect of…

Then there’s pensions – which system looks more like equality to a normal person?

One in which the state provides everyone with a state pension, or has some other form of social security system, or the system we more-or-less had pre-1948 where individuals had to save for themselves. A normal person correctly identifies the former, an inequality economist believes it is the latter.

Again for a, to put it politely, ‘accounting reason’ – in the second scenario the person has their own wealth, which is of course counted, whilst in the first where the wealth ‘belongs’ to the state it is excluded. Consider the difference between how state pensions are treated (uncounted as wealth despite being a speculative future entitlement) versus defined contribution (counted as wealth despite being a speculative future entitlement) and it quickly becomes clear how, in a country with an aging population and thus the growing importance of pensions, wealth statistics become badly wrong especially over time. It’s again a scenario in which more welfare, displacing private wealth that would otherwise exist, quite concretely means more inequality.

There’s a reasonable case to be made that this constitutes a good way to avoid double counting, that is inflating some values by accident, and that’s true enough, but that reasonable case is not extended to corporate earnings where profits are counted both when retained and when later distributed to their shareholders. Something that could be called a rather convenient calculation choice given who shareholders are.

Even NHS spending under Piketty’s and the inequality economist’s framework raises inequality. In-kind benefits are allocated in one of two ways – either uniformly across the population (a straightforward division of the budget by the population) or allocating it based on income.

Now the first approach might make sense for the military, but for the NHS where spending is nearly 4x higher it is embarrassingly off if an understandable simplification. A 20-year old billionaire who has never set foot in an NHS hospital clearly should not be allocated the same benefit from ‘usage of the NHS’ as a normal 85 year old having her second hip replacement and yet this is exactly what happens. The latter approach though is where it gets particularly egregious – saying that our billionaire isn’t just getting the same benefit from the NHS but 5000x the benefit despite it being in theory the same service.

The IFS to its undying credit has extensively debunked both approaches – finding that the bottom fifth get 60% more in cash terms from Britain’s public services than the top fifth.

Finally, and with apologies for the density, there is one more point to make. That even if we take all the assumptions made, even the clearly implausible ones, and accept all of their associated conclusions about inequality, the government is still its cause.

Why?

Again a simple reason – Piketty found that inequality increases because R (the return on capital, increases in asset prices essentially) exceeds G (growth, your wages essentially).

His answer, the same as Gary’s Economics’, the same as Zac Polanski’s, is a wealth tax meant to close that R and G gap. Yet anyone who read his book can see a simple thing – that the rise of capital relative to income was being caused by housing, not big business. That rise is something eminently fixable – and it’s fixable in a sense that is eminently uncomfortable for leftists, requiring governments to get out of the way and let business supply the housing people want.

Ultimately, after all that, what we are left with is an inequality-industrial complex – where expansions of the state cause expansions in (statistical) inequality justifying expansions of the state. Spotting that tautology, and knowing why it’s wrong, has never been more essential.