Andrew Leigh

Why Corporate Australia Should Care About Inequality, Business Insider, Friday, 30 March 2017

When we talk about tax policy, we often say that good tax reform needs to be efficient, equitable and simple. But too often, equity becomes the ugly duckling of that troika – forgotten as soon as it has been uttered. Unless we put equity at the heart of tax policy, our economic debates will fail to address one of the central challenges of our age. Just as no business today can afford to ignore climate change, human capital or social responsibility, so too no business can afford to ignore inequality.

Over the past generation, wages have risen three times as fast for the top tenth (people such as financial dealers and anaesthetists) as for the bottom tenth (people such as apprentices and hairdressers). According to research that I did with the late Tony Atkinson, inequality in Australia is now at a 75-year high. Compared with other countries in the advanced world, Australia isn’t the most unequal. But we are among the upper third for inequality in the OECD.

There are three reasons that business should care about inequality.

First, because more inequality means lower levels of wellbeing. Like the slow shifts of Arctic Glaciers, this can be hard to notice at first – but it’s obvious when you think about the extremes. If we took all the income in Australia and gave it to one person, the average would be unchanged.

But do we really think that we would all be equally happy? In a similar way, the past few decades in Australia have been good times for professionals with harbour views, but hard times for a school cleaner with limited formal education. In economic terms, we’ve seen a rise in both top incomes and relative poverty.

As economists intuitively know, our discipline isn’t about maximising the total amount of money in a society; it’s about maximising the amount of happiness, or utility. If you think that a dollar brings more pleasure to a battler than a billionaire, then you intuitively recognise the prime reason why policymakers should care about inequality. If you’re a utilitarian, you should probably also be an egalitarian.

An unstable society

The second reason why corporate leaders should care about inequality is because a high-inequality society is a highly unstable society. When assets in a society are distributed in a way that most people believe is unfair, it creates a form of systemic risk. You only have to look at places such as Latin America to see the tensions that arise when those in the Favelas don’t feel they’re getting their fair share. When we look at the rise of populist politics around the world, it’s clear that inequality helps foster the sense that mainstream politics isn’t delivering. Any firm with a long investment horizon must by definition care about the stability of the society in which it operates.

And the third reason why inequality is an issue for business is that more unequal societies tend to be less socially mobile. Think of social mobility as being like a ladder. Over the course of a lifetime, some people climb up a bit – doing better than their parents. Others climb down a bit – not doing as well. The more movement that there is up and down the ladder, the more we can think of ourselves as a place where ‘anyone can make it’. The less movement there is, the more feudal our society starts to look.

Now think about inequality as the gap between the rungs of the ladder. In an equal society, the rungs are fairly close together. In an unequal society, they’re widely spaced. Because of this, inequality is a key driver of social mobility. The wider the gap between rich and poor, the harder it is for a child from a disadvantaged background to make it into the middle class. We have strong evidence on this – both across advanced countries and across US cities.

The positive relationship between equality and mobility is a direct challenge to those who say ‘it’s alright to have a lot of inequality, because anybody can make it to the top’. In fact, the evidence shows that when you have considerable inequality, the society becomes less fluid, and more static. Again, businesses should care about this, since they want to be able to access the best talent on offer. A society where your outcomes depend on the luck of birth cannot be as productive as one which makes the best use of all its citizens.

So how does inequality play out in practice in Australian policy debates? Let’s take a few contemporary issues: company taxation, weekend penalty rates, and housing affordability.

On company taxes, the case that is typically made in favour is that overseas shareholders will respond to a lower rate by investing less in other countries and more in Australia – in response to the higher after-tax profits. Higher investment would then, in principle, mean greater demand for land and labour, and thus rising land prices and wages in the long run.

Because the long run is around seven to ten years, and the Turnbull Government’s plan to cut the tax rate to 25 per cent for large businesses doesn’t materialise until 2026, the Coalition is, in effect, promising its benefits to accrue around 2033 to 2035.

How big are those gains? While most commentators have focused on the impact on GDP, the important measure to most Australians is the impact on household income. Here, you really have to squint hard to see a positive story. According to the government’s own modelling, a corporate tax cut that is funded by an increase in income taxes would deliver a gain of 0.1% of household income in the mid-2030s.

So the government is promising a month’s household income gain, delivered in nearly two decades’ time. At a time when corporate profits are strong and wage growth is weak, you can understand why many people are sceptical about a policy that benefits overseas shareholders a decade before it delivers its (very small) benefits to households.

Why penalty rates matter

Then there is the debate over weekend penalty rates. Part of the argument for them is about sustaining community. We have a weekend because it helps families and friends coordinate their leisure time, so they can catch up for a barbecue, a soccer game, or a cup of coffee.

Not surprisingly, those who work on weekends tend to be lower paid than other Australians. By my calculations, the hourly wages of people who work on Saturdays or Sundays average about 80% of the levels of people who work only from Monday to Friday. Without weekend penalty rates, that gap would be even larger.

So when you take away penalty rates, you don’t just make it harder for people to socialise on the weekend – you also increase wage inequality. At a time when wage inequality has been growing for a generation, that’s a pretty tough prescription for the labour market.

Then there’s housing affordability. We know that in Australia, the home ownership rate is now as low as it has been in 60 years. Over the past decade, house prices in capital cities have risen by 72%. In Sydney and Melbourne, house prices have risen 94% and 95%, respectively. CoreLogic data shows Sydney house prices have risen 18% in the last year alone. When house prices are rising at $300 a day, you can’t save for a deposit simply by foregoing a few lattes and smashed avocados.

A major reason for these increases in housing prices has been the unexpected confluence of two tax policies: negative gearing (which allows the deduction of investment losses against wage earnings), and the 50% capital gains tax discount for assets held for more than one year.

Negative gearing came into our tax code in 1936, as a Depression-era stimulus for the economy.[6] The capital gains tax discount emerged out of the 1999 Ralph Review, which didn’t mention housing, but predicted that a lower capital gains tax rate would spur innovation in high-tech firms. The confluence of the two policies acted to send house prices skyrocketing, as investors nudged out first home owners in auctions across Australia. Over recent decades, the home ownership rate for people aged 25-34 has fallen from 60% to 48%.

Tackling housing affordability is a core equity issue. A young Australian couple working as a police officer and a teacher shouldn’t have to choose between having a baby and paying a mortgage. More than that, it simply isn’t fair that our tax breaks are skewed towards the very well off. More than half of the benefits of negative gearing and the capital gains tax discount accrue to the top 10% The immediate result is to increase income inequality.

But the long-term result is to increase wealth inequality, as the largest stock of wealth – our homes – become increasingly owned by a small number of investors, rather than being spread among the population. Over the last two decades, the share of the population renting their home has risen from 20% to 26%.

Yet while inequality is under threat, you don’t get much of a sense of this from reading the leading policy proposals from our top business groups.

Take for example the Business Council of Australia’s submission to the Senate inquiry into the Treasury Laws Amendment (Enterprise Tax Plan) Bill 2016, the Australian Chamber of Commerce and Industry’s Tax & Federation Policy Framework, PwC’s ‘Priorities for an Incoming Government’, or indeed elements of the Minerals Council of Australia’s 2017 pre-Budget submission. None of these documents points to rising inequality as a first-order problem. All of them, if fully adopted, would worsen inequality.

Let’s conclude with a timely example. In a little less than four months’ from now, income taxes will be cut for those with incomes over $180,000. I will benefit from that tax cut, and most business executives will too. This tax cut will deliver $16,400 to a person on an income of $1 million. But most Australians will get nothing.

Indeed, 94% of the benefits of this top-end tax cut will go to the top 1%. As you’ll recall, the top 1% is a group that has doubled its share of national income in the past generation. Is it fair to be cutting taxes on millionaires just a few months after 330,000 pensioners (plus another 190,000 due to the travel restrictions) have been told that their pensions were being cut because the nation needs to ‘tighten its belt’?

What if the nation’s business leaders were to come out and oppose this personal income tax cut – arguing that a ‘temporary budget repair levy’ should not be lifted when net debt has doubled? What if those leaders said that they felt morally obliged to make a greater personal contribution to paying down debt? What if they noted that Australia has the best-targeted social safety net in the world, so cutting welfare spending does more to increase inequality here than in any other country?

I’d guess many Australians would be surprised. Pleasantly surprised. Indeed, it might well be seen as a game-changer in our public debate. A more equal nation will have higher levels of wellbeing, more mobility, and more stability. And it’s the right thing to do.

Andrew Leigh is the shadow assistant treasurer. This is an edited extract of a speech delivered at the Minerals Council of Australia Tax Conference that first appeared in Business Insider on Thursday, 30 March 2017.