Why we’ve got it so wrong on inequality

The economic world is changing rapidly and we need to shift our focus from income to assets

When politicians talk about the gap between the rich and the poor they tend to argue about incomes. One of the battlegrounds of the current Parliament has been the 50p rate of income tax on high earners, which George Osborne contentiously cut to 45p. The Gini co-efficient, a statistical gauge of the gap between incomes at the top and the bottom, is a fixture of the political debate.

But Westminster seems less clued up when it comes to wealth inequality. The reaction to the dramatic pension liberalisation in George Osborne’s latest Budget demonstrated that. The lifting of the requirement on retirees to use most of their accumulated private pots to buy annuities did ignite a debate. But critics’ misgivings have related to the supposed danger of retirees blowing all their nest egg too soon, or ploughing the proceeds into property.

The assumption is that the liberalisation, regardless of whether it is a good thing or not, will have a profound impact across the board. Yet a glance at the distribution of private pension wealth in the first chart from the Office for National Statistics, which breaks down pension wealth by decile of population, shows the major beneficiaries of the Chancellor’s liberalisation will be the very rich.

Between 2008 and 10 the wealthiest tenth of the population had private pension assets of £2.4 trillion. That’s almost three times as much as the next richest decile. Indeed, it’s more than the combined wealth of the bottom 90 per cent of the population combined. The pensions minister, Steve Webb, said last week he was relaxed about the prospect of people squandering their pots on Lamborghinis if they so wished. But the statistics show that it is only the most comfortable tenth of our society who will have the opportunity to splash out hundreds of thousands of pounds in this fashion. The average lump sum annuitised each year is £17,000, according to the Financial Conduct Authority regulator – barely enough for a Lamborghini’s spare wheel. This is a pension liberalisation that matters mainly to the super wealthy.

The distribution of pension wealth, by the way, reflects the bigger picture on asset ownership. The richest tenth of households own 44 per cent of the nation’s overall wealth.

Incomes are redistributed by our progressive tax system. This is the reason post-tax income inequality has remained under control over the past two decades, despite exploding pay at the top end for chief executives and financial sector workers. But the mechanisms for wealth redistribution are much weaker.

There is a strong case for a structural tax switch from income to wealth. The growing cost of health and social care, as the population ages, will place strains on state finances across the developed world over this century. Increasing taxation on growing wealth stocks to fill the hole would be preferable to ratcheting up the burden on a relatively declining number of wage earners.

Yet some politicians are moving in the opposite direction. David Cameron has reactivated the Tory pledge to reduce taxes on inheritance. He has also resisted attempts to increase property wealth. Inheritance and property taxes are unpopular, yet they are a nuisance for the very affluent. An annual levy on £2m mansions (Lib Dem policy) would fall on just 55,000 homes. Put that in the context of a housing stock of 28 million homes. Only 26,000 people paid inheritance tax in the last financial year. Estates worth less than £650,000 are effectively exempt.

While politicians and vested interests resist tax reform, the forces driving inequality are intensifying. The French economist Thomas Piketty argues that returns to capital are now starting to outstrip GDP growth in advanced economies, just as they did in the nineteenth century. That suggests the income from investments will rise faster than wages. The second chart shows wealth disparities are already rising in the US and Europe. But if Piketty is correct, this gap will grow further, heading up to levels last seen before the First World War.

Adair Turner, the ex-head of the Financial Services Authority, sounded his own warning this week, pointing out that a growing share of new wealth flows from the development of internet technologies. The winner-takes-all structure of our modern economies and the growing importance of online firms, he argues, is exacerbating wealth inequalities.

The economic and political debate about what to do about the wealth gap has barely begun. Will new wealth taxes discourage entrepreneurial effort, making us all poorer? Should immovable property take most of the burden? These questions are moot. But make no mistake: the time to start talking seriously about wealth and taxes has arrived.

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