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Predistribution: the neglected side of the inequality debate


The high-profile Toronto Centre federal by-election features two well-known opposition candidates who agree that soaring income inequality, especially the fast-rising income share of the top 1% with all of its well-documented negative effects, is the defining political issue of our times. At issue is what we should be doing about it, through changes to public policy.

In thinking about this question, it is useful to distinguish between policies that affect the distribution of income by the market (called predistribution) and policies that make incomes after taxes and transfers more equal than market incomes (redistribution).

There can be no doubt that progressive income taxes, which bear most heavily on the most affluent, are redistributive. So are income support programs such as public pensions, unemployment insurance and social assistance, which disproportionately benefit lower- and middle-income groups. Most studies show that the spending side is more important than the tax side of the tax-and-income-transfer system.

Data assembled by Professor Michael Veall of McMaster University show that the top 1% of individual Canadians in 2009, those with pretax market incomes of more than $206,900, received 12.3% of all income delivered by the market in the form of wages, salaries and investment income. But their share of all income, after taxes and transfers, was 9.9%.

Taxing well-off Canadians, and spending the proceeds on redistributive income-support programs and other programs such as child care and skills training, expands opportunities for low-income Canadians and increases social cohesion.

There are certainly things that can be done on the redistributive side. Analysts, including the Organization for Economic Co-operation and Development and the Conference Board of Canada, agree that inequality worsened in Canada partly due to major cuts to social assistance and unemployment insurance in the mid-1990s.

Reduced taxation of capital gains income (just 50% of which is now included in taxable income), and the cut in the federal tax rate on corporate profits from 22% to 15%, have boosted the after-tax incomes of the top 1% – many of whom benefit from stock options and have significant income from investments.

That said, the biggest problem is on the market income side. The OECD reported in its landmark inequality study in 2011 that “the single most important driver [of growing inequality] has been growing inequality in wages and salaries.” Here in Canada, the market income share of the top 1% jumped from 8% to 12.3% between 1986 and 2009 – with the consequence that the incomes of middle-class and lower-income families basically stagnated.

There are clearly limits to the ability of the tax and transfer system to counter very rapidly growing inequality of earnings. The evidence suggests that the most-equal countries have remained that way in significant part because the growth of extreme earnings inequality has been held more in check.

In much of Europe, stronger unions and labour standards have helped maintain the growth of middle-class wages. Pay differences between low-wage workers and the middle class, as well as pay differences between CEOs and ordinary workers, are narrower than in North America and Britain. Labour market institutions, social norms and different systems of corporate governance all make a difference.

Some argue that any attempt to compress earnings differentials will come at the price of worse economic performance. But the United States and Britain, the most unequal countries, have not outperformed the advanced industrial countries as a whole over the past two decades of rising inequality. Indeed, there is a strong argument that extreme inequality was a major contributing cause to the 2008 financial crisis and the Great Recession.

A recent paper by Bivens and Mishel published in the Journal of Economic Perspectives argues that pay for senior corporate executives includes a significant amount of “rent,” meaning that pay is much higher than needed to stimulate and fairly reward performance. Many CEO compensation and stock option plans provide huge windfall gains for luck, not for exceptional effort as measured by corporate performance relative to competitors in the same industry.

Serious discussion of reforms to corporate governance deserves to be part of the inequality debate. What, for example, can we learn from the German system of co-determination, which gives employees a voice in how companies operate?

Meanwhile, there is no shortage of economic research that suggests that the erosion of union numbers and bargaining power in the private sector has been a major reason behind the hollowing out of the middle class, the shift of income to the very top, and the rise of precarious and low-paid jobs. Higher minimum wages and enhanced labour rights must be part of the policy debate.

It is challenging to think about what government policies might bring about a fairer distribution of income and rein in the rise of the top 1%. But influencing the predistribution of income is at least as important as government redistribution of income after the fact.

This article originally appeared in the Globe & Mail's Economy Lab.

Photo: mikecogh. Used under a Creative Commons BY-SA 2.0 licence.