The World Inequality Report 2018 released by the World Inequality Lab last week says that income inequality in India has increased since economic liberalisation. This, it notes, is in contrast to the earlier decades when inequality dropped under socialist policies. As expected, the finding has been used by many to argue that the rich should be taxed more to help the poor. The logic is that the rich get richer at the expense of the poor, so taxes that redistribute wealth are only a rational response to inequality.
Less incentive to produce
It is true that the rich and the middle class control a major share of the world’s resources, which consequently is not available to the poor. They enjoy higher incomes from better jobs and investments, which allows them to outbid the poor to purchase various goods. What is not true, however, is that the poor will get to enjoy many luxuries if only the rich were taxed more and the money was used to write welfare cheques to the poor, thus boosting their purchasing power. Instead, when taxes are high, people who help produce the goods that the rich and the middle class enjoy today will have less of an incentive to do their jobs as before. Workers, for instance, may no longer be attracted towards high-skill jobs when their income from such jobs is taxed at high rates. Investors too will have lesser reason to put in their money in crucial projects when their profits are taxed at high rates. In fact, India before economic liberalisation faced this problem when it tried to tax its way to prosperity.
Enabling mobility
Income inequality will always exist in a market economy where people are allowed to engage in free exchange and earn incomes according to their personal capabilities. Doctors, for instance, earn many more times than plumbers and carpenters because they offer rare services. At the same time, however, the higher incomes of the rich and the middle class do not last forever in a marketplace that is free of legal entry barriers. More people will be attracted towards professions and businesses that offer higher returns, which in turn will drive up the incomes of the new entrants while driving down the returns of incumbents. This is why we must look at income mobility, which reflects the number of people moving up and down the economic ladder, and ways to foster it rather than inequality. In fact, income inequality might even widen during times when there is a lot of economic mobility, with the rich getting poorer and the poor getting richer. In such cases, taxes and regulations on high-income earners will only destroy the incentive for others to rise up the economic ladder. A typical case of doing bad in the name of doing good.
