That dress and its macro implications.
Across the advanced economies centre-left parties are more focussed on taxing the better-off and wealth than in recent decades. That may make monetary policy more effective but brings fiscal risks.
A couple of months ago Alexandria Ocasio-Cortez caused something of a stir by turning up to the Met Gala in a rather striking dress.
Indeed, the last time I can remember the internet being so obsessed with a dress was back in 2015. Of course, back then there was an active debate on whether that particular garment was black and blue or white and gold whereas the meaning of AOC’s dress was somewhat clearer.
If AOC wanted to grab attention, she certainly succeeded. But, from a global political economy point of view, what is more interesting is that she certainly isn’t alone in her desire to raise taxes on the rich.
Left of centre parties have, in general, always supported higher taxes on the better off as part of an active programme of redistribution. But, until recently, that was usually part of a wider programme of higher taxes on most workers to fund public services and transfer payments.
In the last few years something has begun to change.
A clear enough example comes from Britain. Almost twenty years ago, in 2002, the then Labour Chancellor Gordon Brown increased payroll taxes (in the form of a rise in national insurance contributions) to fund higher spending on the National Health Service. This was, by late twentieth or early twenty-first standards, a pretty standard bit of social democratic policy making – a broad based tax rise on workers and employers to fund public services. At the time, much of the British left welcomed the move as being closer to traditional Labour values than the cautious approach to tax-and-spend that New Labour had demonstrated in their first term in office.
This September Britain’s Conservative government increased national insurance contributions to fund the NHS1. The move was not welcomed by the British left. Instead they attacked for the government for raising taxes on low and middle income workers rather than the rich2.
Under Jeremy Corbyn, Labour argued for a much larger state but for taxes to only rise on those earning over £80,000. Labour’s current tax policy, as is fair enough at this stage in the electoral cycle, is less explicit. But the tone, mood music and the policy pledges so far, all point in the same direction.
The Biden administration is, in its rhetoric, equally explicit.
They say everything is bigger in America and $400,000 is certainly a lot higher than £80,000.
And this isn’t something neatly contained in the Anglo-American political sphere either. Norway’s Labour Party returned to power this Autumn on a manifesto based around increasing taxes on the better-off and cutting them for most workers. Across Europe left of centre politicians are singing from the same hymn sheet. There has been a rediscovered interest in wealth taxes alongside higher income tax bands.
I suspect the trend has two major drivers. A decade or more of weak wage growth in most major economies has, presumably, dimmed the public’s enthusiasm (in as much as it ever existed) for higher taxes. Alongside that, the work of Piketty and others has driven a renewed interest in levels of inequality and the made the language of the “the 1%” all the more common.
Telling most voters “you can have nice things and someone else will pay for it” is, of course, not a bad political offer. Although as the 2017 and 2019 British elections demonstrate it is not a clear cut road to victory either.
But, even if it makes sense from a political point of view, does it make sense from a macro-policy point of view?
On one level, the answer is a clear yes.
In his final speech as a member of the Bank of England’s monetary policy committee Jan Vlieghe argued that high levels of wealth and income inequality had impaired the usual functioning of macro-policy. Together with demographic change they pushed down the neutral rate of interest, lowering the policy space available to the central bank. They also increased levels of debt, making economies more brittle and prone to shocks.
As he put it:
I also summarise some new research that links debt, income inequality and wealth inequality. Recent research argues that the fundamental driver is income inequality, and higher debt and wealth inequality follow from it. Higher income households want to accumulate assets, including lending to lower income households. This increases private debt and lowers interest rates by acting as a credit supply shock, by making economic outturns riskier due to a higher probability and severity of financial crises, and possibly by weighing on future consumption demand of indebted households.
The policy implications are even more stark than when I first discussed them nearly six years ago. We have limited headroom for easing monetary policy, so we will not be able to provide monetary stimulus on the same scale as in previous recessions. QE headroom, which should be measured in basis points of yields rather than in billions of bonds available for purchase, is limited as well.
By this view, the taxation of wealth and higher income tax bands at the top of the distribution – in as much as they materially reduce post-tax inequality – could help improve the overall effectiveness of macro-policy.
But the macro-policy outcomes of a shift in the nature of taxation are not entirely clear cut. A decent principle for prudent (to use one of Gordon Brown’s favourite pre-2008 words) fiscal policy is to not narrow the tax base.
Back in 2008-09 Britain managed the unfortune combination of one of the largest government deficits (as a share of GDP) among the advanced economies and one of the smallest discretionary fiscal stimuluses. The deficit blew open not because of aggressive fiscal support for a demand-deficient economy but because the tax base had become too dependent on frothy asset and property markets. At just the time when the economy most needed fiscal support, the Treasury found itself fretting that the deficit was already blowing out.
Switching the basis of taxation towards the rich and wealth may help make monetary policy more effective, but it brings the risk of public finances more vulnerable to sudden shocks. Like most macroeconomic policymaking, there are trade-offs.
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This was sold as a move to fund social care, but for the rest of this Parliament the vast majority of the revenue raised is earmarked for helping clear the NHS pandemic-related backlog. And, if you think the government will actually be able to reduce NHS funding in the mid-2020s, then I have a bridge to sell you.
And there is a fair enough point here that a rise in income tax would have been better than a rise in NICS. But I am not sure a rise in the basic rate of income tax would have gotten a much warmer welcome from the Labour Party.