An inequality tax [Archives:2005/894/Business & Economy]

November 14 2005

The economic booms in China and India have helped to reduce global inequality. Over the two last decades, masses of Indians and Chinese have closed the gap (in relative terms) with the rich world.

But, at the same time, many of the world's truly poor countries have fallen further behind (particularly in Africa, where developments are often described as catastrophic), and inequality within most countries has risen. Widening inequality has been recorded in the United States (starting with Ronald Reagan's administration), the United Kingdom (starting with Margaret Thatcher), Russia during its privatization, and more recently in China and India.

These developments seem to add to global inequality. So, on balance, it seems that global inequality has been relatively stable during the last two decades.

Should anything be done about this? Many think that no global action to fight economic inequality is necessary. They argue that only poverty reduction matters. In the words of Anne Krueger, the Deputy Managing Director of the IMF, “Poor people are desperate to improve their material conditions ather than to march up the income distribution [ladder].”

Thus, even if the absolute income gap between an average American and an average African increases, why worry? After all, such people argue, the average African would be a bit less poor.

But this assumes that our income relative to the income of others does not matter. On the contrary, psychological studies invariably show that people care not only about their absolute income, but also about where they stand in the social pyramid and whether their position is fair.

In the past, a poor African might have looked at his compatriots and resented their wealth; now, both he and his better-off compatriots look at the rich world and resent the huge income gaps they see. The gaps are most obvious where people from different countries work together, as in many multinational companies. An “expatriate” may be paid ten times more than local staff for the same job.

A wage premium based solely on citizenship is grating. But even when people do not work together, globalization, by bringing the world to everyone's living room (or hut), enables them to make much wider comparisons of their living standards. It erodes the relative security in which the rich world could shelter itself, as in a cocoon. Now, all can see these income differences.

This is why international action to address both global poverty and global inequality is needed. Global redistribution through taxes that would be levied by an international body may seem far-fetched today, but the logic of development that we are witnessing – particularly the move away from nation-states as the locus of sovereignty – suggests that it may eventually come to pass.

One such opportunity was missed in the early 1990's. When Russia faced its worst crisis, aid was given to the corrupt Yeltsin regime. But it should have been disbursed directly in cash to the most needy Russians: pensioners whose earnings plummeted due to inflation and economic contraction. An international organization could have simply used the existing infrastructure of the Russian state to distribute cash grants to some 20 million pensioners – money that would have been much better targeted and spent than by giving the same amount to the government.

If this had been done, Russians would have fondly remembered receiving cash aid from the international community rather than blaming it for transferring funds to corrupt leaders. But the same or a similar approach could be taken in many countries today, from Angola to Zimbabwe.

The approach is simple and powerful. It involves three steps: raise money from the globally rich, do not deal with governments, and transfers funds in cash to the poor.

Those who advocate leaving globalization exclusively in the hands of the private sector may resent the idea of vesting tax-raising authority in a global agency. But they cannot fail to notice that the processes they support undercut their own position by rendering the wealth gap more obvious and the fairness of the actual global distribution more questionable. They will ultimately realize that their self-interest lies in supporting some form of global action to deal with both poverty and inequality.

Branko Milanovic is an economist with the Carnegie Endowment for International Peace and the World Bank. His most recent book is Worlds Apart: Measuring International and Global Inequality.