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Andrew Jackson: The Distribution of Wealth: Implications for the Neo Liberal Justification for Economic Inequality

Nobel Prize winning economist and political theorist Amartya Sen points out that “every normative theory of social arrangements that has at all stood the test of time seems to demand equality of something – something that is regarded as particularly important in that theory.” Even extreme neo liberals such as Robert Nozick who reject the goal of distributive justice and favour a maximum role for free markets and a minimum role for democratic governments demand equality of individual rights to freely participate in an economy based upon predominantly private ownership of property and free markets. Capitalism is all about equal access to individual freedom to deploy labour and capital as individuals see fit, as opposed to pre liberal economic systems based upon slavery and serfdom.

Building upon this normative foundation of equal access to the market, neo liberals argue that economic inequality is acceptable because market outcomes in terms of the distribution of income and wealth are basically fair since they reflect individual effort and skills and the productive contribution of the individual to the economy as a whole. (A sub argument is that a free enterprise, market economy is the best way to promote high productivity and efficiency and a higher level of overall income and wealth. This can, if society so wishes, be used to provide assistance to the poor and to fund programs. like public education and access to health care, which promote more equality of opportunity.)

US Federal Reserve Chair Ben Bernanke puts the central argument as follows:  “Although we Americans strive to provide equality of economic opportunity, we do not guarantee equality of economic outcomes, nor should we. Indeed, without the possibility of unequal outcomes tied to differences in effort and skill, the economic incentive for productive behavior would be eliminated, and our market-based economy--which encourages productive activity primarily through the promise of financial reward--would function far less effectively.”

Thomas A. Garrett, an economist with the US Federal Reserve Bank of Saint Louis, expands upon this  conventional neo liberal view of  economic inequality in an admirably succinct way: “It is important to understand that income inequality is a byproduct of a well-functioning capitalist economy. Individuals’ earnings are directly related to their productivity. Wealthy people are not wealthy because they have more money; it is because they have greater productivity. Different incomes reflect different productivity levels. The unconstrained opportunity for individuals to create value for society—and the fact that their income reflects the value they create—encourages innovation and entrepreneurship .....A wary eye should be cast on policies that aim to shrink the income distribution by redistributing income from the more productive to the less productive simply for the sake of 'fairness'."

These core propositions are enormously influential, and are to be found in one form or another in the first chapter of most introductory economics textbooks.

There are many possible lines of criticism of the argument that the distribution of  rewards by the market fairly reflects the productive contribution of individuals. (I do not address here the argument that inequality is essential to economic efficiency except to observe that there is no consistent relationship between the level of inequality and the level of economic performance among advanced industrial countries such as Canada.)  

Nobel Prize-winning economist Joseph Stiglitz argues in his recent book The Price of Inequality that there is really no such thing as a pure free market economy which rewards individuals based upon their own skills and efforts. While economists are quick to equate the level of individual wages and salaries with an individual’s contribution to the overall economy, it is hard – if not impossible – to identify the individual productive contributions of individuals who work as part of large and complex social organizations within a highly integrated and inter-dependent economy. We know, for example, what Prime Minister Steven Harper is paid, but does that really tell us what his individual contribution is to the Canadian economy?   

Stiglitz further argues that, quite unlike a textbook economics world of competitive markets, many parts of the actual economy we live and work in are dominated by large and powerful corporations. These establish market dominance through their competitive strategies, privileged access to information and other means, and also by lobbying for government rules and regulations which bolster limited competition. In a truly competitive economy, profits would be driven down to low average levels, but, in the real economy, corporations can and do earn large “rents” or above average, excess profits which an be used to enrich senior management and shareholders. The financial sector also manages to earn large returns from activities which contribute little or nothing to overall productive efficiency. CEOs and other senior corporate management insiders can and do pocket large incomes far in excess of their real productive contribution to the enterprise they lead or to the economy as a whole. In short, there are many cases in which individuals and corporations get out-sized economic returns because they wield a significant degree of power within the market.

A second line of argument is that a capitalist economy is marked by predominantly private ownership of the “means of  production” and that ownership of productive assets is highly concentrated in the hands of relatively few people. The actual economy is not one in which the great majority of people work for themselves as small producers, but rather one in which they are are employed by large enterprises, predominantly in the private sector. The final distribution of income in such an economy reflects not just the distribution of wages and salaries (which may, or may not, be relatively fair based on individual skills and effort) but also on returns to capital as opposed to the returns to labour, and the extent to which ownership of  capital is concentrated.

In a capitalist economy, individuals are equally free to deploy their capital as they see fit, but they do are not true equals since their original endowments of capital are far from equal. Yet ownership of capital carries with it significant claims upon the economic surplus or value-added produced by the economy as a whole. Profits play a functional and important role in the market economy as a signal of where to invest and as a source of funds for the renewal of depreciated capital and new rounds of investment. But it is hard to argue that increments to wealth and the profits received by wealthy individuals as dividends and capital gains are “earned” in the same way as wages and salaries.    

Consider a simple example. An important employer in a community is an office. Wages average $50,000 per year and are distributed to the 200 employees in a way that is generally seen to be fair  based upon skill and effort. Wages total $10 Million per year. Profits amount to $2 Million per year, half of which are re-invested each year, and this is the level needed to maintain a viable, ongoing operation by replacing depreciated capital and by making needed new investments. $1 Million is paid out as a dividend each year to the owner of the company, who inherited it from his mother, lives in Bermuda, and plays no active role in the company operations which are directed by a senior manager. Is it fair that the owner has a return from the enterprise which is twenty times higher than that of the average worker? Would it be unfair for the workers to form a union and demand a pay increase which ate into the dividend, but still left enough profit to maintain needed investment?

Approximately 10% of all household income in Canada comes from interest and financial investments, not counting income earned from unincorporated businesses which is a mixture of income from capital and income from labour. That number does not include substantial annual increments to household wealth arising from increased share values and claims on corporate assets not distributed as income. Wealth, especially financial wealth, provides security as well as income and  can be drawn upon by those who have it to purchase goods and services on the market above and beyond what they can command based upon income alone.

One does not have to be a Marxist to see that concentrated ownership of private property in a market economy poses important distributional issues which are hard to justify in normative terms. These have long been apparent to intellectually honest liberal thinkers.  Even Friedrich Hayek, the spiritual founder of contemporary neo liberalism, wrote in his seminal work The Road to Serfdom that “(i)n a system of free enterprise, chances are not equal since such a system is necessarily based on private property and (though perhaps not with the same necessity) on inheritance, with the differences of opportunity which these create.”  John Stuart Mill famously argued in his Principles of Political Economy (Book 2) that a large progressive inheritance tax should be levied to ensure that private property did not become too concentrated in a few hands, and in order to prevent economic advantage from being inherited.   

The central point is that it is hard to argue that the distribution of economic resources by a “free enterprise/ free market economy” is fair if ownership of capital is highly concentrated in a few hands. This is especially the case if large concentrations of wealth are inherited rather than built up out of current income. Yet this is very much the case in Canada today.

Wealth is made up of assets minus debts – with the major asset categories reported in surveys being housing, pension assets and financial assets such as stocks, bonds, and mutual funds held outside of pensions. In 2005,  the most recent year for which data are available, 41.5% of all household assets consisted of financial assets, mainly held in pension plan and RRSP investments.

The ownership of net wealth (assets minus debts) is much more concentrated than the highly unequal distribution of income and has, like income, been becoming much more concentrated. The most recent data show that the top 10% of households - with average net worth of $1.2 Million – owned 58.2% of all net wealth in 2005, up from 55.7% in 1999 and 51.8% in 2004. Meanwhile, the bottom half of Canadian families owned just 3.2% of all wealth in 2005. (3.2% is not a typographical error.) While households do tend to accumulate more net wealth over the life course, the majority accumulate remarkably little. The median Canadian (half have more, half have less) has net wealth of little more $200,000 before retirement.

The official statistics under-state the real degree of concentration of wealth, especially financial wealth, since they are based on sample surveys. While efforts are made by Statistics Canada to over-sample in affluent neighbourhoods, the fact remains that surveys are extremely unlikely to include the ultra rich who are few in number but own enormous quantities of wealth. Lars Osberg (2008) estimates on the basis of previous studies that the top 1% today own about one fifth of all net wealth.

Preliminary income tax data for 2010 show that persons with incomes over $250,000 – representing just 186,520 persons or 0.75% of all tax filers – declared 10.1% of all taxable income. (This  understates their share of income since only 50% of capital gains income is reported for tax purposes and counted as income.) Taxable income from investments was highly concentrated among this group, which accounted for fully one half (49.8%) of all taxable capital gains income; one third (35.6%) of all dividends; and one fifth (17.5%) of interest and investment income. (Note that these figures do not capture all capital gains and dividend income since some of this income is sheltered from tax in pension plans and RRSPs.)

The same data show that about one third of the taxable incomes of the top 0.7% of income earners  making more than $250,000 came from investments – 15.8% from capital gains, 12.2% from dividends, and 2.5% from interest. (In making these calculations, reported capital gains and dividend income have been adjusted to show the actual rather than taxable amounts. Both capital gains and dividends are significantly less heavily taxed than income from wages and salaries. Indeed, only 50% of reported capital gains is liable to tax.)

Those at the very high end of the distribution of wealth have extremely large fortunes. According to Forbes’ Magazine annual rankings for 2012, Canada has 25 families or persons with more than $1 Billion in assets, the top 5 of whom are the Thomson family ($17.5 Billion); the Galen Weston family ($7.7 Billion); the Irving family ($5 Billion); Jim Pattison and Paul Desmarais (tied at $4.3 Billion; and Ted Rogers ($1.7 Billion).  Clearly, at this elevated level, great wealth in many instances has been accumulated over more than one generation.

According to Statistics Canada, inheritances play at least a modest role in the accumulation of wealth. 36% of families in the top fifth ranked by net wealth had received inheritances, averaging $136,600, much more than the 10% of families in the bottom one fifth who received inheritances worth an average of $13,200.

To conclude, wealth, especially financial wealth, is highly concentrated in Canada and produces a significant source of income and economic well-being for the rich which is not earned in the same sense as income from wages and salaries. At a minimum, inequality of financial wealth reinforces inequality of income, and bequests of wealth between generations can be very large. This is hard to justify on the normative grounds used by neo liberals to justify economic inequality, namely that individual rewards reflect the productive contributions of individuals. Accordingly, it is not “unfair” to consider taxation of inheritances and large accumulations of wealth or to reflect on other means to reduce large concentrations of private wealth.

Andrew Jackson is the Senior Policy Advisor at the Broadbent Institute, and Packer Visiting Professor of Social Justice at York University.