Sunday, 23 March 2014

Why the rich get richer, and what this means for the tax system

There have been lots of articles in the papers over the past week resulting from the recent Oxfam report into the richest poorest members of society. It seems that the richest five families in the UK have as much wealth as the poorest 20% put together. That is five families against nearly 13 million people. This is unsurprising in that the richest are the richest and have a hell of a lot while the poorest are the poorest and have little or nothing.

However, the scale of the difference does not indicate that some people are saving while others are spending. Richard Seymour’s piece highlights how this difference is largely a result of the adage that “money follows money,” “money begets money” or “money makes money.” These can be understood to mean that people who have money find it easy to make more money, or alternatively that the children of the rich end up rich themselves. Both of these are usually true unless there is a highly redistributive or economically restrictive regime.

There are obvious reasons why the rich can easily get richer while the poor will find it very difficult to get richer. The wealthy can give their spare money to financial institutions, or just sit on their property and watch it increase in value. The poor have to use most if not all their resources on the basic costs of living, leaving little left over for investment. Wealthier people, by contrast have the same amount of time available to them to work and earn in that way, while earning money on invested capital. Meanwhile, any money they earn can be invested rather than used for necessaries. Furthermore, poorer people may need to take jobs with few prospects as they need money quickly while richer people can take a longer view and more easily develop a career.

Of course, you may get rich people who are very bad with their money and blow it all. Occasionally someone from a less wealthy background will build a business or obtain a very highly paid career. But these are anomalies, and the processes described above will tend to lead to greater and greater concentration of wealth over time unless checked. Which leads on (did you guess?) to taxation.

If we are looking at what to tax, there are very clear arguments to tax the returns to capital in preference to taxes on the income and consumption of the less-well-off. Certainly revenues above the change in the value of money should be taxed on a progressive basis. This is not punitive—people should be able to invest and earn something from this after tax. The punitive approach would discourage investment and that would be very bad for the economy. But it still makes sense to be taxing returns to capital at high rates in order to reduce taxes on those with low incomes.

Unfortunately things seem to be going in the opposite direction in many ways, as I will discuss in my following blog. 

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