To preserve democracy, tax the rich

A progressive tax system would redistributes incomes to the poor while preserving incentives for the rich

COMMENT | KAUSHIK BASU | While there are many ways to measure economic inequality, key metrics consistently show that disparities are getting worse. According to a recent United Nations report, 71% of the world’s population now live in countries where inequality has increased.

Unsurprisingly, this includes India and China. A recent paper by Thomas Piketty and his co-authors shows that the income share of the top 1% in India has risen to its highest level since 1922, the earliest data that they have, when the country was still under British colonial rule.

At the same time, global inequality remains extremely high. While billionaire wealth has reached unprecedented levels, the World Bank estimates that 712 million people worldwide survive on less than $2.15 per day.

Future generations will likely be shocked that we have tolerated such extreme levels of inequality, just as we are horrified by our ancestors’ acceptance of slavery. But as David Hume argued in the eighteenth century, moral imperatives (“ought”) cannot be derived from objective facts (“is”). In other words, problems like inequality cannot be resolved through science or reason alone. Instead, we must highlight their moral implications to persuade people to act.

Two key aspects of global inequality deserve particular attention. First, economic disparities are set to worsen both within and across countries. As technological advances like artificial intelligence reduce demand for human labour, working-class households around the world could become increasingly impoverished. Meanwhile, those who own the machines and run the largest corporations are expected to amass unprecedented power and wealth. The United States – home to nearly 38 million people living below the poverty line despite being one of the world’s richest countries – provides a glimpse into this bleak future.

Second, extreme inequality poses a mortal threat to democracy, enabling billionaires and moneyed interests to influence elections, capture traditional and social media, and shape public perceptions. Regrettably, judging by social-media chatter and trolling, some of the strongest opposition to progressive taxation and redistributive policies comes from the poorer segments of society, largely owing to misinformation and manipulation.

The toxic combination of extreme inequality and AI-powered misinformation is also a factor fueling pressure on liberal democracies and the rise of authoritarian forces around the world. By enabling a few wealthy individuals to wield disproportionate influence, today’s global economy increasingly marginalises and disenfranchises much of the world’s population.

To be sure, misguided attempts to reduce inequality also carry significant risks. For example, trying to achieve perfect egalitarianism would be unwise, because some disparity is necessary to create incentives. Similarly, concentrating all wealth in the hands of the state, as the Soviet Union did, would lead to mismanagement of demand and supply and, ultimately, cronyism.

Instead, what we really need is a progressive tax system that redistributes incomes from the rich to the poor while preserving incentives. Fortunately, there is significant scope for such measures. In my recent book Reason to Be Happy, I propose a tax regime that I call the “accordion tax,” which aims to narrow the income gap by taxing high earners and transferring the revenue to those with lower incomes.

While this model essentially functions as a progressive tax system, its strength lies in its micro structure. Beyond a certain point, the super-rich no longer seek to earn more to buy things. Simply put, after the fifth yacht, the sixth is merely a status symbol aimed at outdoing other wealthy individuals.

By taxing all incomes above a certain threshold and transferring this money to those earning below it, governments could reduce inequality without harming incentives. The richest person will remain the richest, and the second-richest person will work just as hard to reach the top. But the incentives of the middle and working classes, whose members work primarily to make ends meet rather than try to surpass their neighbors, will remain intact.

Although the accordion tax could act as a powerful tool for reducing inequality at the national level, today’s globalised economy poses significant implementation challenges. If a government taxes high incomes too aggressively, it risks triggering capital flight.

Thus, reducing global inequality requires multilateral agreements. While the U.S. is well-positioned to lead this effort, its ability to do so depends on the outcome of November’s presidential election. Vice President Kamala Harris, the presumptive Democratic nominee, offers hope for greater distributive fairness. By contrast, a victory for former President Donald Trump will likely cause inequality to worsen. We can only hope that American voters make the right choice.

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Kaushik Basu, a former chief economist of the World Bank and chief economic adviser to the Government of India, is Professor of Economics at Cornell University and a non-resident senior fellow at the Brookings Institution.

Copyright: Project Syndicate, 2024.