Asking good questions is half the battle in advancing knowledge, and a clever and timely piece by Andreas Georgiadis and Alan Manning of the London School of Economics does just that.
The post looks into why rising income inequality isn’t strongly correlated in democracies with more concerted efforts at redistribution. After all, as wealth becomes concentrated in fewer hands, the have nots, who outnumber the top echelon in considerable numbers, will have both the incentive and the means to vote for policies that make the after-tax distribution of income less skewed.
The post by Georgiadis and Manning makes an interesting first cut into the problem. It looks at the relationship between income inequality in the UK from 1974 to 2004, a period during which the disparity in earnings grew sharply, and social attitudes towards redistribution. Although there was a time from the mid 1980s to the mid 1990s when the desire for redistribution increased, over the long haul it has declined dramatically. The authors offer some theories, the most persuasive being that rising inequality give the rich the means to fight off demands for reallocation (ie, they are better able to manipulate public opinion).
The standard framework for thinking about inequality and redistribution – the median voter approach – predicts that rising inequality should produce more redistribution. The facts reject this prediction for the UK and suggest that beliefs may be an important missing factor.
“I warn you that there are going to be howls of anguish from those rich enough to pay over 75% on their last slice of earnings”, a gleeful Denis Healey, Labour Party Shadow Chancellor, 1973.
“The justice for me is concentrated on lifting incomes of those that don’t have a decent income. It’s not my burning ambition to make sure that David Beckham earns less money”, Tony Blair, Labour Party Leader, 2001 Election Campaign.
One of the main activities of the state in democracies is to redistribute resources. The most common explanation for why the state gets involved in this activity is that the distribution of income is skewed with small numbers of large incomes so that average income is above median income. In simple models of democracy, it is the median voter who is decisive and the government effectively does what they want, and they will typically want to redistribute resources from the rich to themselves. More sophisticated models of democracy also tend to have the same prediction. According to this view, a rise in income inequality will lead to more redistribution as the median voter tries to get a slice of the extra pie going to the rich.
However this prediction about the relationship between inequality and redistribution does not fare so well when confronted with data. Perhaps the starkest comparison is between the United States and Europe. The United States has higher levels of inequality than Europe and less redistribution, the opposite of the views sketched above. (See Alesina, Glaeser and Sacerdote, 2001, for a good discussion of this comparison).
However, there are many other potential differences (e.g. racial divisions and the political system) between countries that muddy the link between income inequality and redistribution. While the existing studies do make serious attempts to control for these confounding factors, it is very difficult to do this in a way that is beyond reasonable criticism.
However, it is not just across countries but also over time that we see changes in inequality. Looking at how redistribution in a country responds to changes in inequality has the potential advantage that many factors that might be thought to be relevant to redistribution (e.g. the political system) are held constant so we might hope to get a better estimate of the impact of inequality on redistribution. That was the purpose of our research on the relationship between inequality and redistribution in the UK.1
The UK is a good country to consider because it has had large rises in pre-tax income inequality that are generally thought to be the result of the exogenous forces of technological change and globalisation. In particular, there has been a large rise in the share of pre-tax income going to those at the top of the income distribution. As discussed above, most models of the political process used by economists would predict that the political response to this would take the form of rising redistribution with rising marginal tax rates on the rich. But we show that this has not happened. In our research, we use a sophisticated way to arrive at this conclusion but the simplest way to see it is that the top rate of income tax fell from 83% in the late 1970s to 40% in 1988 since when it has not changed. There is now no major political party proposing rises in the top marginal rate of income tax.
Why has the rise in UK inequality been met with so little demand to increasing taxes on the rich? One possibility is that the models of the political process used by economists are all wrong. For example, if our democracy is closer to ‘one pound, one vote’ instead of ‘one person, one vote’ then a rise in the share of income going to the rich will also lead to a rise in their share of political power, hence potentially explaining the lack of a redistributory response. But it is also possible that other factors have been changing.
To investigate this we used data from the British Social Attitudes Survey to see whether attitudes towards redistributive taxation have been changing. The answer is that they have. The figure below shows the average response of individuals to the statement “government should redistribute income from the better-off to those that are less well-off” where a 1 represents strongly disagree and 5 strongly agree so that higher average values represent a greater demand for redistribution.
From the figure it can be seen that the demand for redistribution fell in the early 1980s but then rose from the mid 1980s to the mid 1990s. This was the period in which inequality grew fastest and it seems plausible to argue that the lack of redistribution by the Thatcher and Major governments was not particularly popular. Hence Tony Blair would seem to have inherited in 1997 a large unmet demand for redistribution. But, little happened to actual inequality or redistribution but the support for redistribution plummeted to the lowest level available. The bottom line is that inequality now is much higher than in the 1970s but the demand for redistribution is much lower.
Why the change?
Why might people’s attitudes to redistribution have changed so much? There are a number of possible explanations. First, if you care a lot about the poor or are very envious of the rich, it is quite likely that you support a lot of redistribution. Secondly, if you believe that high taxes discourage work then you are not likely to support much redistribution. If you think the government cannot be trusted you are less likely to support redistribution. We find evidence for all these predictions using the British Social Attitudes Survey as well as the standard prediction that the rich favour less redistribution than the poor.
But have any of these attitudes been changing over time? Our conclusion is over the last 10 years that changing attitudes towards incentives and changing attitudes towards the rich (fewer people now believe there is one law for the poor and one for the rich or that big business benefits owners at the expense of workers) can explain almost two-thirds of the decline in the demand for redistribution in the UK.
One way to summarise this conclusion is that what people believe is as important as the objective economic circumstances in explaining people’s attitudes to political issues like redistribution. And these beliefs can change fast. Such a conclusion is perhaps only a potential surprise to economists as it simply says that politics is a battle for ‘hearts and minds’. But where those beliefs come from is itself an interesting question that we cannot answer very easily – it may be that they themselves are a product of the economic fundamentals. For example it could be that the rise in inequality gives the rich more power to fight off demands for redistribution and the way in which they do this is to put resources into persuading people that incentives are very important or that big business is not all bad. The determinants of what people believe is an area where economists are only beginning to focus their attentions.