Andrew Leigh

CLOSING THE INCOME GAP

2015 Economic and Social Outlook Conference

University of Melbourne

If you returned from work one day and found your home flooded by a gushing faucet, the first thing you’d do is turn off the tap. But once you’d stopped the water rising, could you then go about your evening as though nothing else was amiss? Only if you’re willing to overlook the rather pressing problem of everything you own being underwater.

That’s the approach some would have us take in response to the news that there has been a pause in the growing gap between the rich and the rest in Australia over the past few years. When the OECD released a report earlier this year showing that some measures of inequality had been stable in Australia between 2006 and 2012 – some newspaper columnists and political commentators welcomed this as a sign people like you and me should stop worrying about how much better Australia’s billionaires are doing than our battlers.

But to extend the analogy a little further: turning off the tap is not the same as draining out water. The fact that inequality has stopped rising for the moment does not mean that we’ve suddenly achieved an egalitarian idyll. Across the advanced world, Australia sits in the top third for our level of inequality.

In other words, Australia still has a serious inequality problem. We should not let the past few years’ pause lull us into thinking it has gone away. In fact, this is perhaps the most dangerous time for opportunity and equity in this country. Without the urgency of an escalating problem, I worry we’re coming to accept the status quo. We’re becoming so accustomed to seeing inequality around us that we’re losing sight of how unfair it really is.  

So for today’s conversation I have two objectives. First, I want to talk about how great Australia’s inequality gulf still is, and how we got here. Then, I’ll flag a few key ways we can actually start closing the gap, rather than just holding it steady.

Inequality has become a silent wedge that divides us one from another. I believe the increasing rancorousness of public debate in the past decade, the rise of outright rent-seeking from some quarters and the divisive approach taken to issues like public infrastructure funding and education are direct consequences of Australia being more unequal. When our community is split off into ‘us’ and ‘them’, we lose the common ground that makes sensible policymaking possible. We won’t find our way back there whilst ever opportunity and fairness are so far out of balance.            

A century of inequality

Australia started the 20^th century as a country of haves and have-nots – in 1910 the top 1 per cent of income earners received 12 per cent of total income while the top 0.1 per cent received around 4 per cent. Those of you who are quick with numbers will have already worked out that represents 12 times and 40 times their respective shares of the population.

Fortunately for the other 99 per cent of Australians, that inequality didn’t survive the Second World War and the host of equalising policies put in place by the Chifley Government. By the mid-1950s, the income share of the wealthiest Australians had dropped from 12 per cent to 8 per cent; by the start of the 1980s it had fallen even further to 5 per cent.

In my book Battlers and Billionaires, I compiled a list of the all-time richest Australians – those with personal wealth greater than 0.17 per cent of national income in their day. This list alone maps out the story of Australian inequality all too clearly. Almost half of those who make this list built their wealth before 1900. But from 1940 to 1980, no Australian was rich enough to earn a spot on it. 

For forty years, Australia was mogul-free as incomes grew faster for those at the bottom than those at the top, and capital found its way into a larger number of Australian hands.

But then in the 1980s, inequality came roaring back like a power-blue Ferrari GTS. Since Neighbours first went to air on Australian TVs, the income share of the top 1 percent has doubled. The income share of the top 0.1 percent has tripled.

Cumulatively, the increase in the affluent share over the past three decades represents a $403 billion shift from the bottom 99 per cent to the top 1 per cent.

It’s not just income. Wealth inequality has increased too. The top 1 percent’s wealth share has gone up significantly since the 1970s.

The wealth share of the top 100,000^th of the population (approximately the top 200 people) has tripled since the mid-1980s
A significant portion of the rise in Australian inequality over the past decade relates to changes in the labour market. Work is the principal sources of income for most households, and the gap between the well-paid and low-paid has been steadily growing.

From 1975 to 2014, real wages have risen by $7000 for the bottom tenth, but $47,000 for the top tenth. Put another way, the top tenth of Australian earners have received a pay rise that is bigger than the total pay of the bottom tenth.

In percentage terms, those at the bottom have seen an earnings rise of 23 percent, while the top have seen an earnings rise of 72 percent – over three times more. If cleaners and checkout workers had received the same proportionate pay rise as solicitors and surgeons, they would be $16,000 a year better off.

So what changed? One reason for the revival of inequality is the decline of union density over this period. If you want a single institution in the Australian labour market that acts as a bulwark against inequality, it’s unions. Unions tend to bargain for dollar pay increases – which disproportionately benefit those at the bottom. They advocate pay equity across firms and across industries. Unions have also underpinned key campaigns for pay equity for women and Indigenous Australians.

Another major driver of inequality is the twin forces of technology and globalisation. Computers can now beat chess world champions and fly a helicopter. Global outsourcing is possible with everything from record-keeping in healthcare to designing your website. It’s true that some high-wage occupations are under threat, but the more prominent effect is what economists call ‘skill-biased technological change’. This is the general rule that technology tends to raise the wages of high-skill workers more than low-skill workers. For example, the computer revolution in law firms helped raise the earnings of partners, while rendering thousands of typists redundant.

I gave a lecture at Northwestern University in Chicago last week which looked at the ways technological innovation and digital disruption will likely continue to push down wages for those without skills while eating away at routine jobs in the middle of the wage distribution. We should welcome innovation and a world where bright minds are constantly coming up with ways to do things faster, smarter, cleaner or safer. But that doesn’t mean we should also welcome the inequality that comes with this. If innovation’s natural tendency is to increase the gap between the rich and the rest – as it has so far and seems likely to continue doing in future – then we need to make sure we have policies in place which exert an opposing force.

So Australia has become dramatically more unequal over the past generation. Since the Global Financial Crisis, inequality has not risen much, but it certainly has not receded. We need to keep this issue on the national agenda because the choices we make as politicians and policymakers can have a real impact on whether the wealth gap grows or shrinks.

If we stop worrying about inequality, we’re likely to see the top start accelerating away from the bottom again. If we consciously focus on policy interventions that advance opportunity and fairness, I am confident can shrink the gap and the social problems that come with it.   

What can governments do?

It’s trendy to be sceptical of government’s capacity to effect change these days. I don’t deny that the increasingly open nature of Australia’s economy and society have diminished the number of things government can directly control, and increased the number of big players vying to guide where we go as a nation. But tackling inequality is one area where the levers for change are very much in the hands of the government of the day.     

For example, the Rudd Government’s decision in 2009 to boost the single age pension by over $1600 a year took a million people out of poverty.

The Gillard Government’s National School Improvement Plan was also aimed at distributing resources more fairly to improve outcomes for those in disadvantaged areas. And the National Disability Insurance Scheme reflected the fact that disability and poverty too often run together.

Governments can also make a difference on inequality that runs the other way – as the current government illustrated with its first two budgets. These were full of policies that, if enacted, would have led to Australia becoming a more unequal country. For instance, the government’s first go at cutting family tax benefits and paid parental leave would have shrunk the disposable income of the poorest fifth of Australians by 7 per cent a year. At the same time, families in the top income band would have actually ended up slightly better off.

Looking ahead, there are lots of big picture, long-term things we can do to reduce inequality – like investing better and improving teacher quality in public schools; prioritising re-training for people who are likely to be displaced by technological change at work; and encouraging an ongoing role for unions in representing the lowest-paid workers.     

There are also three more specific areas where I believe we should be focusing our efforts in the next few years. Ideally we would see the current Government move on these things; but if not, Labor will make them a priority when we are fortunate enough to regain office.

Continue to focus on the tax and transfer system

No nation’s welfare system is perfect, but none is more efficient at reducing inequality than Australia’s. The average advanced country gives twice as much welfare to the bottom fifth of the population as to the top fifth, while Australia gives twelve times as much to the poor as to the rich. But this is a political choice, not a guaranteed outcome. Under the Howard Government, the redistributive effect of government payments declined by one-quarter. Labor took the opposite approach when we were in government by increasing the use of means testing to ensure those who received transfer payments were those who really needed them. This will continue to be a hallmark of our approach in the years ahead.   

The Howard years also saw the introduction of several structural changes to the tax system which have, over time, disproportionately ended up benefiting those at the top of the distribution. You would be aware that there is a debate underway at the moment over the tax treatment of superannuation and the broader suite of concessions relating to capital gains, negative gearing and other types of investment income. While this debate can quickly get mired into the weeds of tax system design, the big picture is that some of our current settings are contributing to the inequality gap.

When the top 10 per cent of income earners receive about 38 per cent of all super tax concessions, that reinforces inequality. When someone earning over $180,000 a year pays 30 per cent less tax by pouring money into super while someone earning less than $18,000 pays 15 per cent more tax for doing so, that reinforces inequality. When the tax breaks which allow an investor to purchase their third property become an obstacle to a young family buying their first, that reinforces inequality. And when income earned through sources other than work is taxed at concessional rates or subject to deductions which aren’t available to regular wage earners, that too reinforces inequality. There’s no ‘politics of envy’ or ‘class warfare’ involved in pointing this out. It’s a simple statement of fact that if some government expenditure flows disproportionately to those who are already at the top of the distribution, then this will increase their wealth relative to those who do not receive the same benefits.

Labor has already announced our plan to scale back superannuation tax concessions to address the current inequity. We’re also engaged in an ongoing conversation with experts and community sector representatives about how reforms to negative gearing may improve equity in the tax system. Bill Shorten and Chris Bowen have been clear that any future policies should not disadvantage those who’ve made investments in good faith under the current settings. But we’ve also been upfront in saying that this is an area where we believe Australia’s tax settings can be made fairer.

More generally, there is a conversation worth having about the complex range of deductions, concessional rates and offsets our tax system is riddled with, and how harmonising or removing some of these might also improve equity and address the inequality gap. In September, respected economist Saul Eslake likened our tax system to ‘a giant Swiss cheese’, and argued that tax loopholes which lacked a strong economic justification should be closed. This is an important conversation and I’m hopeful that with the change of leadership at the top of the current government, we might be able to have it in a less shouty way than has been the case over the past two years.     

Analyse how policies affect inequality

Like those of you, I believe in the power of good data to improve decision-making. So it won’t surprise you that my second priority for tackling inequality is to analyse the distributional impact of policies. In particular, we should make holding new proposals up to the light to examine their equity impact a standard part of the policy process. We should also be evaluating existing programs more regularly and rigorously to see if they are adding to, reducing or failing to touch the sides of the inequality gap.   

For example, it was not until the Murray Financial Systems Inquiry published its report in 2014 that the Australian community at large came to understand just how much our current super settings skew towards the well-off. Prior to this analysis being run and published by an authoritative voice, there was not the will to do anything about them. Similarly, one of the defining moments in the failure of the 2014 Budget was NATSEM’s release of modelling showing that the lowest-income families would be over $3,000 a year worse off while the wealthiest would actually end up with slightly more in their pockets. We cannot fix distributional problems that we cannot see, so in the argot of the internet, we need ‘MOAR DATA’.

Treasury does conduct modelling on the distributional impact of some of tax concessions as part of preparing the annual Tax Expenditures Statement. Off the top of my head, here’s a handful of other existing policies it would be worth examining in the same way: farm grants, the wine producer rebate, the private health insurance rebate, and the zone tax rebate. Similarly, we require environmental impact assessments for big initiatives in the resources and infrastructure portfolios; why not also make equity assessments routine for new or changed policies in areas like social services, education, health and tax?

Consider inequality in competition policy

Finally, the government is currently preparing its response to the most significant review of competition policy since the Hilmer Review in the 1990s. In his terrific new book Inequality: What Can Be Done?, Oxford’s Tony Atkinson suggests that inequality should be an explicit focus of the competition agenda. Atkinson argues that since the decisions regulators make about mergers and pricing can have a direct impact on cost of living and service access for consumers, protecting those at the bottom of the income distribution from things like price spikes and monopolies should be given greater emphasis.  

This isn’t an idea which has garnered much attention in Australia to date. But in a recent working paper in the US, Jonathan Baker and Steven Salop expanded on some of the specific ways competition policy could more explicitly target inequality, including: prioritising competition lawsuits with a direct consumer element (that is, over cases where those affected are primarily other businesses); designing remedies that advantage low-income consumers (for example by allowing a merger on the proviso that the new company improve network access in under-serviced areas); and adopting inequality as a specific consideration on the checklist of factors considered in competition cases (as the Canadian Competition Tribunal has done since 2002). While there is more work to be done to see how these proposals might fit into Australia’s specific competition policy framework, I agree with Tony Atkinson and other authors who argue there is strong potential here.

***

A few months ago, the Ford Foundation, one of the world’s most important philanthropic foundations, announced that it was shifting its grant-making entirely to addressing inequality. Shortly afterwards, Justin Trudeau became Prime Minister of Canada based in large part on a campaign that argued his nation should not accept steadily rising inequality. Across the globe, leaders from Pope Francis to Barack Obama have pointed out that inequality is one of the central challenges of our age.

I’m an optimist by nature. I’m deeply worried about the rise in inequality Australia has seen over the past generation. But I’m also confident we can reverse this if we make the right policy choices as a nation. That means forging ahead now with inequality-busting initiatives because as I said a few moments ago: turning off the tap is not the same as draining out the water. The current pause in the growth of inequality is the moment for us to double our efforts on closing the gap. It would absolutely be the wrong move to treat this as an opportunity to move on to some other crisis instead.

Inequality remains a major challenge for Australia. But the good news is that no nation has a stronger egalitarian tradition than ours. We should draw on our values to ensure that prosperity is fairly distributed, and opportunity remains within the reach of everyone.