ANZ NZ's economics team looks at key themes for 2015; This final section looks at income inequality and in part calls for a capital gains tax, including on the family home

Over six articles we're publishing a detailed outlook from ANZ NZ's economics team on six key themes for 2015.

Here is the final one. (Links to the previous themes are at the bottom of this page.)

By Cameron Bagrie*

Income inequality matters.

Quite apart from moral questions of fairness, income inequality has real economic implications.

Recent OECD research (Focus on Inequality and Growth – December 2014) shows that rising inequality hurts growth, and the reasoning is simple; poorer members of society invest less in education.

So let’s start by looking at a few key statistics, bearing in mind that there is a wide array of measures for inequality and they can tell different stories: that old adage of lies, dammed lies and statistics still applies.

KEY STATISTICS ON INCOME INEQUALITY IN NEW ZEALAND

New Zealand income inequality is middle of the pack, according to the OECD. At 0.32, New Zealand’s Gini coefficient is similar to Australia’s (0.33).

Chile is the most unequal country in the OECD, while Scandinavia dominates the other end.

But while New Zealand’s income inequality may be middle of the pack, it is considerably higher than it was before the mid-1990s according to the Ministry of Social Development (MSD).

Some other key statistics from MSD3:

• The top decile received eight times the income of the bottom (after tax and transfers) in 2011.

• The top 1% of households received around 8% of all taxable income in 2010 and 2011. This is more than in Scandinavia (5 to 7%), similar to Australia, but much lower than the UK (14%) and the US (17%).

• Wealth inequality is usually around double the level of income inequality (using the Gini measure). The wealthiest 10% hold around 50% of all household wealth, whereas the top 10% of income earners receive a 25% share of all income. New Zealand’s wealth inequality is about average for the OECD.

UNICEF has calculated that roughly one in five New Zealand children (18%) live in poverty. This figure is derived from the proportion of households earning less than 60% of the median income. New Zealand’s level is ahead of the US (33% living in poverty) and the UK (25%), but behind Germany (15%), Australia (13%) and the Scandinavian nations (<12%).

WHY DOES INCOME INEQUALITY MATTER?

A degree of income inequality is to be expected – and is indeed desirable – in any market driven economy.

Rewarding and encouraging entrepreneurial fortitude, investment and risktaking boosts economic growth. People need to be incentivised to work harder and innovate.

But it is pretty intuitive that high degrees of income inequality aren’t good for growth either despite the empirical evidence regarding the impact of income inequality on growth being mixed.

Addressing excessive income inequality can enhance economic growth in several ways.

• It can help extend expansions. Those with lower incomes consume a larger proportion of their incomes. If too much income growth goes to the top earners, consumption can be hollowed out.

• It helps grease the wheels of an economy via a little bit of inflation. We fear high inflation but deflation is just as bad. Just look at the last generation in Japan. With labour’s share of income sitting at lows in the likes of the US it’s of little wonder inflation is dormant. Lifting that share requires material lifts in incomes, and it’s not just at the lower end, with a lot of pressure on middle income groups too. That doesn’t mean ramping up wages is the policy solution; wage increases not backed up by improved productivity can be inflationary and there are competitive issues to consider. Rather it highlights that getting more discretionary spending power into people’s pockets is required.

• Those at the bottom of the ladder tend to be more vulnerable during cyclical downturns, suffering more when growth falters and unemployment rises. This exaggerates boom/ bust cycles.

• An income distribution that is perceived as broadly fair can reduce political pressures and thereby encourage the pursuit of sound microeconomic policies which promotes the “long game” and stability. If a large proportion of the population is “missing out” on the good times, they will look for scapegoats. These are likely to take the form of more hostility to free trade agreements, inward migration, or inward or outward foreign investment; factors which can enhance overall growth. An aggrieved populace also supports populist policies that can ultimately undermine economic performance.

• Excessive, entrenched inequality tends to lead to a wide divergence in education quality and quantity across society. An education system should ideally provide a level playing field: fostering talent regardless of who one’s parents are, or their income.

There is another important factor to consider on the education front: the world is changing rapidly, and economies need to be mobile and well educated in response.

Globalisation and technology – particularly robotics and automation – threaten jobs and incomes in fields further up the skill spectrum than ever before. It’s no longer just about robots assembling cars. It’s software replacing accountants and computers making medical diagnoses.

A 2013 University of Oxford study concluded that computerisation threatens just under half of US jobs. They also find a strong negative correlation between wages and an occupation’s probability of computerisation. Increasing technology will inevitably be a force acting to increase income inequality: the occupations likely to be computerised are already (or soon will be) at the lower end of the income spectrum.

Of course, innovation and technological advancement isn’t (generally) a bad thing: it improves productivity and growth, and has allowed an increase in human leisure time. Who would want to feed the world without tractors and combine harvesters? Write this article with a typewriter? Or return to the days when the household laundry took a full day each week?

However, change brings disruptions to deal with, and in the shorter term particularly, there are losers as well as winners. These disruptions could be unruly if people in aggregate across the economy do not have the skills and flexibility to adapt to change.

WHAT CAN BE DONE?

First up, while it matters how the pie is cut up, you need a decent pie to start with. Measured inequality in New Zealand might have been lower in 1984, but the economic ship was sinking back then. Tackling hard issues can cause hardship and widening inequality, but a failure to do so can result in a bigger bomb down the track.

Any attempts to ameliorate income inequality must be very carefully designed with marginal work and risk-taking incentives at the micro level firmly front and centre. There is a reason why communism failed. Reducing the relative rewards that come from risk-taking and hard work will reduce risk-taking and hard work. A degree of income inequality is a necessary if unpalatable by-product of providing the sort of incentives that lead to higher living standards.

To some extent the degree of income inequality is a political choice that depends (among other things) on the value society places on the size of the pie, versus how evenly it is sliced up. Of course some nations are fortunate enough to simply be presented with a more appealing range of choices. Norway, for example, with its strong national balance sheet and high real wage levels, can sustain significantly higher income tax rates while remaining competitive in the global skilled labour market. New Zealand does not have that luxury. In this section we are not aiming to recommend one societal choice over another, but rather look at ideas of how – short of a massive oil find – the system might be able to be tweaked at the margin for the greatest aggregate benefit – to improve the choices society faces.

Whether for economic or political reasons, the prevailing political breeze in New Zealand is running strong on the topic. Income inequality and derivatives of it (housing affordability, child poverty) will be high on the agenda in the 2015 and subsequent Budgets and central to the 2017 election. And that makes good economic sense if an elongated expansion is to be achieved.

The debate in New Zealand seems more proactive than in most countries. We’re not saying a full-blown strategy is being implemented and the problems are being addressed; far from it. However, answers to some tough questions are being sought.

Here are some broad concepts.

• First, we need acceptance that it’s a groupwide and national problem. A piecemeal solution won’t work.

• Don’t just let the free market sort it out; that’s about as sensible as letting rugby players referee themselves. But equally, a whistle-happy referee ruins a game. Strike a balance.

• You need growth to drive job creation, which drives income growth. However, jobs are a means to an end – not an end in themselves. Returning to the 1980s days of negative value-add assembly industries or thinking the Government can do things cheaper than the private sector is not the answer.

• Raise take-home pay; you go about that by cutting taxes, not raising them. That’s achievable in a fiscal sense only with prudent management of the Crown’s accounts and keeping a lid on spending demands. Means testing national superannuation, or raising the retirement age would provide scope to lower income tax rates.

• There needs to be a ruthless obsession with lifting productivity growth, the precursor to sustained lifts in real wages. Considerations such as raising the minimum wage are only sustainable if there is the productivity growth to support them. The business sector is pivotal but you don’t create a seamless, well-oiled, efficient machine with poor infrastructure and regulation.

• Shift attention from the top earners to lifting the bottom. Rather than chopping down tall poppies, it is far more useful to focus on improving the fortunes of those missing out.

• Housing needs to be affordable. Housing costs now chew up 16.3% of household income, compared to 15.4% in 2007. The costs are highest in Auckland, despite higher incomes. The longrun picture is starker: in 1984, only 3.3% of New Zealand households were paying more than 40% of their income in housing costs; today it is nearly 13%. That’s a massive shift.

• The same applies to food. For developed countries, New Zealand sits at the higher end of the spectrum for the proportion of income spent on food consumed at home (15.4%). For those with lower incomes it is a bigger burden. Part of this is due to the fact that New Zealand exports a large proportion (in many cases more than 80%) of most of its agricultural produce. This means New Zealanders have to pay the “world” price, and in many cases New Zealand has preferential access to higher-value markets and receives a premium. Net-on-net this is an economic benefit to the nation. However, anyone that travels or migrates to New Zealand immediately realises how expensive it is to eat. Forget about tweaking GST; that’s a populist gimmick. The issues are broader. If the Productivity Commission can be unleashed to look at housing affordability, then they can look at food too.

• There should be a capital gains tax on housing – including the family home. An across-the-board capital gains tax might be politically unpalatable, but a rising share of income is now coming from housing-related capital gains (and inherited wealth). Labour income accrues more evenly than capital income.

• Financial literacy needs to lift. Financial intermediaries can (and are) playing a role here.

• Any strategy needs bipartisan support. Income inequality is a long-term issue, and flipflopping policy won’t change long-term behaviours. A second or third-best policy solution – though not economically “pure” – may well be the better option if it brings less risk of a U-turn over the long haul. But this requires the political fraternity to think about group and national interest and not self (political posturing) interest. Alas, economic theory (game theory) shows the latter tends to dominate.

• There needs to be strong regional involvement and engagement. Central government can provide the broad settings at the aggregate level, but regional performance needs to be led locally. Doubters of this should compare Taupo and Rotorua today versus Queenstown and Wanaka 15 years ago. What applies for growth applies equally for social issues; hence the requirement for regional engagement.

• Education is absolutely critical, particularly in light of ongoing innovation and rapid technological change. It’s an investment. It is also a factor that is naturally amenable to government intervention: a market failure exists due to the fact that the benefits from education accrue to more than just the individual – the market will under-deliver if left to its own devices. Research shows that inequality hinders education – human capital accumulation, in the jargon. Low income can become a trap, as the unaffordability of additional education makes it nigh-on impossible to break out. It can also reduce opportunities for the next generation. That nexus needs to be broken. More than ever, the system needs to be about learning to learn, to make individuals responsive to a rapidly changing environment. The education system itself also needs to be agile in responding to the changing needs in key sectors (such as information technology) and areas of competitive advantage. Strong integration with eventual prospective employers is key.

Education is such a critical element that it is worthy of further discussion.

Not only is there a need to increase the number of people undertaking professional development and higher education, but equally there is a need to constantly adapt the curriculum of different disciplines. New Zealand is producing more tertiary graduates. However, the mix isn’t great. Creative arts bachelor degrees have outnumbered information technology degrees by nearly three and half times since 2008. In the primary sector space, a recent study showed 20% more qualified workers will be required over and above business as usual to deliver industry strategies by 2025.

Outside of the formal education sector, professional development also needs to keep pace with rapid changes. While there are many professions that have fallen by the wayside over the last 100+ years, there are many others that still exist but operate vastly differently to 50 years ago or even more recently. With the opening up of markets, the reach of multinational companies, the internet age, better supply chains and general globalisation, change in business practices and product offerings occurs more quickly. Such rapid change means different professions and the tools and skills they utilise need to be more agile.

According to OECD data, of New Zealand’s population aged 25-64, just over 40% had a tertiary education in 2012, up from 29% in 2000, and well above the OECD average of 33%. However, New Zealand has gone largely sideways in the past ten years.

WHAT IS ALREADY BEING DONE?

Action to tackle income inequality is being taken on a number of fronts (and this often precedes the incumbent Government).

Here is quick overview of some key initiatives.

• Housing affordability: the Government has fast-tracked areas in Auckland for housing development, is reforming the Resource Management Act to free up land, striking numerous housing accords and has also launched an enquiry into why construction costs are so high in this country compared to Australia. But it’s not a magic bullet.

• Child poverty has been lifted up the Government’s priority list in response to clear societal discomfort about the current situation. OECD research says New Zealand poverty rates generally aren’t too bad, and are quite good amongst the elderly, but the nation scores less well for child poverty. See the Children’s Commissioner’s Expert Advisory Group’s report “Solutions to Child Poverty in New Zealand: Evidence for Action” for data and recommendations on the issue.

• Health: Although there has been some criticism, the Whanau Ora programme has been introduced to provide more targeted health initiatives to Māori who are often at the bottom end of the income spectrum. Free GP visits and prescriptions are to be extended for children under the age of 6 to 13 in July.

• Financial literacy is making its way into more parts of the school curriculum. KiwiSaver and saving is becoming progressively ingrained in the national psyche.

• Productivity: we seem to be pushing all the right buttons here with driving a more productive public service, a wide-ranging microeconomic reform programme (the Business Growth Agenda), asset sales (deepening capital markets and freeing up money for reinvestment), using the Productivity Commission more, and reducing red tape. A more generous tax treatment of R&D spending would be another helpful move.

• Education: Examples here include a stronger focus on raising student achievement, particularly in the early childhood arena, new teacher and principal roles (performance pay by disguise), more tuition subsidies for science in the tertiary sector, and the establishment of more Centres of Research Excellence). But stepping back – New Zealand still produces too many arts graduates and not enough in technology, engineering and science. Arts degrees are cheap to supply, but the price signals will not provide an optimal outcome in this instance. The relative price lever (i.e. student fees) doesn’t just need to be tweaked, it needs to be given a damn good rip.

• The Government’s 'investment' style approach to its spending and balance sheet management.

That’s non exhaustive, but it is clear steps are being taken, and it’ll be at the forefront across the political arena over the coming years.

THE BOTTOM LINE

New Zealand finds itself in an enviable position where improving economic fortunes (amidst volatility and extensive change) offers optionality to address challenges and circumvent economic issues.

If the economic cycle is to be durable and elongated – the long game – then inequality issues will need to be addressed.

There is a rubber band; there will always be divergence in incomes.

It’s now looking taut.

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*This report was written by the ANZ New Zealand economics team which consists of chief economist Cameron Bagrie, senior rates strategist David Croy, senior economists Sharon Zollner and Mark Smith, economist Peter Gardiner, senior FX strategist Sam Tuck, and rural economist Con Williams. It is used with permission.

A link to Theme 1 - Change is the new normal, is here.
A link to Theme 2 - Localised focal points, is here.
A link to Theme 3 - The trend is your friend, is here.
A link to Theme 4 - Our key downside risk, is here.
A link to Theme 5 - Liquidity vs fundamentals, is here.