WEF Davos 2020: Social Mobility: Towards a New Public Finance

In January 2020, at the WEF 2020 in Davos I met with a wonderful group of speakers and panellists across sectors to find actionable solutions to the challenge of social mobility. In this session we discussed the effect of inequality on social mobility and the role of tax systems and tax avoidance in its perpetuation. I was joined on the panel by Magdalena Andersson, Minister of Finance, Sweden; Laura D’Andrea Tyson, Distinguished Professor of the Graduate School, Haas School of Business, University of California, Berkeley; Peter Orszag, CEO, Financial Advisory Board. The panel was facilitated by Minouche Shafik, Director, London School of Economics and Political Science. Below are my key takeaways and arguments during this panel:

Today, we are living in a world with a potentially explosive conjunction of toxic “-isms”: protectionism, populism, nationalism, parochialism. They are themselves the symptoms of anxieties of people for their jobs, for the future of their children, and vis-à-vis technological change, digitalisation and globalisation more generally. These mounting worries and fears have actually moved countries away from commitment to working together. Unfortunately, the recent Broken Elevator and Squeezed Middle Class reportconfirms people’s perceptions; the middle classes are squeezed and shrinking and the share of wages in GDP keeps falling. Today, 14% of jobs are at high risk of being automated, while a further 32% could face substantial changes in the way they operate. As high as 65% of children today will have jobs that have not yet been invented.

Instead of fuelling innovation and new opportunities, these fears are leading to distrust and fractious politics. Down the line, policy makers produce misguided policies and a vicious circle of lack of cooperation establishes itself.

Measuring the Impact of Inequality on Social Mobility

The OECD has been at the forefront of documenting the rising levels of income inequality and the lack of opportunities that many OECD countries have experienced over the past 30 years. Inequalities of income, wealth and opportunities within countries are at their highest levels across many countries for 30 years. In terms of inequality, the incomes of the top 1% have been rising particularly fast, while the income gap between the top 10% and the bottom 10% is now almost 10 times, up from 7 times in the 1980s. When it comes to wealth, the top 10% in the income distribution holds more than half of the total wealth [as much as 79% in the US], while the bottom 40% accounts for only 3%. These numbers translate into an increasing sense of economic insecurity – more than 1 in 3 people are economically vulnerable, meaning they lack the liquid financial assets needed to maintain a living standard at the poverty level for at least three months.

Children are most affected by inequality of opportunities. Children born to parents who did not complete secondary school have only a 15% chance of making it to university, compared to a 63% chance for children whose parents attended university. Health outcomes, and even life expectancy, are also heavily influenced by their socio-economic background. These unfortunate outcomes are all down to the fact that the “social elevator” is broken. It would take 5 generations (150 years!) for a child born into a low-income family to reach the average level of income in OECD countries. At the bottom, “sticky floors” prevent upward mobility for too many people. Children from disadvantaged families have weak chances of moving up. For instance, nearly 1 in 3 children whose fathers are in the bottom earning quartile will remain there. On the other hand, “sticky ceilings” are holding people at the top. Children born into greater privilege are less likely to move down the ladder; 40% of sons of fathers in the top earnings quartile will stay there. Against this backdrop, there is a widespread sense, including in advanced OECD economies, that the social contract underpinning our societies no longer works for the majority of citizens.

OECD’s findings[1] suggest that a majority of citizens believe levels of inequality are too high. On average, 70% an OECD survey respondents want to see a reduction in the share of income held by the top 10%. In addition, around 60% of middle-income households say they do not receive a fair share of public benefits, given the taxes and social security contributions they pay. Their concerns are legitimate, as their incomes have been growing much more slowly than higher incomes for more than three decades now. Looking beyond redistribution is quintessential to issue policy recommendations that incorporate equity as a driver of growth. Because we have long operated on a “wrong” mantra of “grow first, redistribute later”, GDP became an end in itself instead of a means to an end. The issues that come with this principle were revealed during the financial crisis, a dramatic wake-up call of the levels of inequality around the world. Only a small portion of the population captured the majority of the benefits of our growth, while the rest face the tough effects of the decoupling of wages from growth. The benefits of growth and integration have not trickled down, and it is essential that we recognize that this mantra does not deliver in terms of reducing inequalities. We know as a fact that inequalities are bad of the economy – it hinders growth (i.e., productivity-inclusive nexus, a large financial sector slowing economic growth). New and improved models must be developed to ensure that the focus on growth actually improves lives. A multi-dimensional solution should be adopted in this discussion to tackle inequalities from both an economic and a societal point of view.

The Impact of Globalisation and Technological Advancements on Inclusive Growth

According to the report previously mentioned, jobs will change due to automation, with 1 in 6 middle-income workers whose jobs are at high risk of automation[2].  Skilling, reskilling and upskilling are crucial steps for guaranteeing employment of low and middle-income workers, but those who need training the most actually train the least – Low-skilled workers are 40 percentage points less likely than high-skilled adults to participate in training. This urges us to imagine a different roadmap to ensure we do not leave anyone behind.

Evidence clearly shows that highly unequal societies are also bad for business. The failure to consider inclusiveness and equity aspects in the design of socio-economic policies prevents individuals and businesses from attaining their full potential, thus holding back aggregate productivity and economic dynamism. If not accounted for in policy and decision-making, megatrends such as climate change, globalisation and digitalisation are likely to deepen socio-economic divides, and put the most vulnerable in even more precarious situations.

Hence why the OECD developed the Productivity-Inclusiveness Nexus, which shows that more egalitarian societies have more solid and cohesive growth outcomes. In many economies today, the business environment is characterised by a “best versus the rest” phenomenon. For instance, a study of 24 OECD countries showed that labour productivity of the top 5% manufacturing firms grew at an average annual rate of 2.8% between 2001 and 2013, compared to 0.6% for other manufacturing firms. Worryingly, this growing gap between the most and least productive firms is reflected in wage divergence and rising inequality. Wages paid by top-performing firms in the services sector are about twice as high as wages paid by firms in the middle of the productivity distribution. Against this backdrop, it is essential to boost productivity convergence of laggards to help achieve inclusive growth. OECD work shows that policies that reduce barriers to technological diffusion help increase the productivity of laggard firms. These policies include training aimed at specific population groups, better access to finance for SMEs, and direct R&D support. Moreover, young businesses have a key role to play in job creation, considering their high productivity growth potential.

A new reality in business is required to promote inclusive growth, which can be implemented through strong business leadership and political will. In this spirit, the OECD has launched, with the support of the G7 French Presidency and with Danone, the Business for Inclusive Growth Platform. The 40 multinational member companies of this platform will take concrete actions to promote diversity, inclusion and responsible conduct within their companies and their operations. Companies have already “earmarked” 72 projects worth about USD 1 billion as potentially impactful and typically represent from USD 5 million to more than USD 25 million of total commitment per company.

Last but not least, one of the most important contributions we have been making to promote inclusive growth is through international tax cooperation to address the issue of tax havens. It is worth celebrating that our fight against tax evasion and erosion has already delivered EUR 102 billion in additional revenues. This is money that can effectively be invested in policies that take account of distributional effects and dynamics over the life-cycle for different groups, particularly to promote early childhood education and care and access to affordable quality housing.

Breaking the Cycle of Inequality Using Tax Systems

There are many different visions of what constitutes a desirable level of redistribution – policy makers do not all agree on what they think is an acceptable level of inequality of outcomes. However, a broader agreement can be reached around the idea of equal opportunities – that all people should have the same life chances, regardless of their initial conditions. Discussing about how to fix the “social elevator” that is broken today is a priority. Innovative policy tools can include tax progressivity, the means beyond redistribution, as well as international cooperation on the fight against tax havens and corporate tax evasion to promote inclusive growth.

In fact, as a number of economists have recently highlighted, including Gabriel Zucman and Emmanuel Saez, the tax system is a new engine of inequality. In general, OECD tax systems are less progressive than they used to be 30 years ago. Top personal income tax rates have indeed declined; from an OECD average of 65.7% in 1981, the tax rate has significantly decreased to 41.4% in 2008 and has seen only a slight push to 43% following the financial crisis. Taxes on personal capital income (i.e. dividends, capital gains and interest income earned by individuals) have also decreased since the 1980s, andtaxes on property and wealth transfers play a smaller role than they used to.

There is room to enhance the progressivity of tax systems to address income inequality. This could be achieved by removing tax expenditures that primarily benefit the wealthy, but also by ensuring effective tax enforcement. Tax systems could play a bigger role in addressing wealth inequality, particularly through more broadly based and potentially higher taxes on personal capital income and well-designed inheritance taxes. However, there is no one-size-fits-all solution because it all depends on the national circumstances and its tax base.

In countries where top tax rates are already high, the focus should be set on raising effective tax rates by removing regressive tax expenditures that benefit the wealthy (i.e., mortgage interest deductions, private pension contribution deductions and favourable tax rates on capital gains). While enhancing progressivity, scaling back such tax benefits improves efficiency by reducing distortions. Enhancing tax enforcement is also a crucial measure to raise effective tax rates on high earners. In addition, progressivity can also go beyond personal income taxation, by, for instance, introducing progressivity in property taxation.

For developing countries, different approaches may be necessary when using the tax system as a means to address inequality. Usually, a large share of their economy is informal and personal income taxation represents a small share of their tax revenue mix. Personal income taxes represent 10% of total tax revenues in Latin American countries on average, 15% in Africa, while 25% for OECD countries. Consequently, enhancing the functioning of existing income taxes is a priority. Additional options include making better use of taxes on immovable property (i.e., housing taxes), and applying indirect taxes on luxury products. Tax reform should not be considered on its own when addressing income inequality because it is the overall impact of the tax and benefit system that matters.

On average across OECD countries, ¾ of the income redistribution occur through transfers, while the remaining quarter is the result of taxation. For example, the potentially regressive effects of increases in carbon taxes might be compensated by the introduction of greater progressivity in other tax areas and by income redistribution through direct transfers.

Concerning wealth inequality, there is also a case for making better use of tax systems to address this issue. There are existing tax tools (i.e., personal capital income taxes and inheritance taxes) that can help address wealth inequality, but countries have not been using these tools to their full potential. The OECD generally recommends starting with these existing tax instruments rather than introducing a wealth tax. Nevertheless, there are national circumstances where there might be more room to consider wealth tax, notably in countries where taxes on personal capital income or inheritance are low. In addition, there is still a lot of room to improve the taxation of household savings, as well as the role of inheritance taxes to narrow wealth gaps.

Capital Mobility Constrains Policy Making

Capital mobility used to constrain national policy with the taxation of movable capital (stocks, bonds, etc.) being generally taxed at lower rates than other types of income to avoid capital flight. In the last 10 years, the work on tackling issues like tax evasion and corporate tax avoidance has progressed very fast and the OECD has been a leader in setting international standards and monitoring their global implementation in two key areas. Firstly, tax transparency is crucial to ensure that tax cheats have nowhere to hide and that tax administrations can request and receive information from these jurisdictions. Such information relates to ownership of companies or bank accounts, for example. The second area of work is fighting tax avoidance by multinational enterprises (Base Erosion and Profit Shifting (BEPS) project). In 2015, the OECD delivered a package of fifteen measures to help countries close the loopholes and fill the gaps that MNEs exploit to pay little to no tax.

There are three ingredients to keep having successful outcomes, which starts at enhancing the political will, a work which the G20 and the EU have been spearheading. The co-operation between the EU and the OECD has been fruitful, with the EU helping to push the agenda forward. Secondly, multilateral cooperation through broad membership – the two bodies in charge of the implementation of these standards are the Global Forum on Tax Transparency and Exchange of Information for tax purposes (Global Forum) which includes 158 members, while the Inclusive Framework on BEPS has 137 members. The low and zero-tax jurisdictions are part of these two groups, which helps ensure their commitment to reform. Another key element to success is the robust peer reviews the jurisdictions of the two bodies provide about one another to ensure a level playing field. This will help putting pressure on those jurisdictions that are lagging behind. The objective of the OECD list is not to “name and shame”, but to apply political pressure on those lagging behind in order to ensure their compliance with tax transparency norms. This list continues to shrink – clearly showing progress and providing encouragement for the OECD. It included 15 jurisdictions at the end of 2018, but thanks to progress made, there were only 7 jurisdictions reported as not having satisfactorily applied the OECD tax transparency criteria in October 2019. Further progress will be reported at the next G20 Finance Ministers Meeting on 22-23 February 2020.

Results

On Tax Transparency, the progress is impressive. The OECD is proud to say that bank secrecy is over, with 97 jurisdictions that are exchanging information on financial accounts automatically. In 2019, around 6 100 bilateral automatic exchanges of information took place between these 97 jurisdictions, representing a 36% increase from 2018. As for the contents of the exchanges, in 2018 (the most recent date for available figures), information on 47 million financial accounts was exchanged, with a total value of the accounts of around EUR 4 900 billion. This figure is expected to increase significantly. As of today, 135 jurisdictions currently participate in the Convention on Mutual Administrative Tax Matters, which is the most comprehensive multilateral instrument available for all forms of tax co-operation to tackle tax evasion and avoidance. As for the impact of all this, a study by the OECD estimates that in the period 2008 to 2019, the progress on tax transparency is associated with a decline of 24% of bank deposits (USD 410 billion) in international financial centres. Moreover, EUR 102 billion in additional revenues (tax, interests and penalties) have been identified for collection through voluntary disclosure programmes and offshore investigations. 

On BEPS, there is a steady and successful implementation of the four BEPS Minimum Standards. As a result of the OECD’s work to address harmful tax practices, approximately 30 000 information exchanges related to previously secret tax rulings have occurred since 2016. Additionally, over 290 preferential tax regimes have been reviewed since 2015 and virtually all of the regimes that were identified as harmful have been amended or abolished. These regimes had previously allowed multinational enterprises to avoid tax on their international activities, contributing to base erosion. Since June 2018, more than 80 jurisdictions have engaged in the exchange of Country-by-Country reports (CbCR) on the activities, income and assets of multinational enterprises, allowing tax administrations to better target their resources and audit activities. Furthermore, 93 jurisdictions have signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS, which allows governments to modify existing bilateral tax treaties in a synchronised and efficient manner to implement the tax treaty measures developed during the BEPS Project.

This work is carried out in an inclusive manner. The body in charge of the implementation of the tax transparency standards (the Global Forum on exchange of information and transparency for tax purposes) has 158 members, whereas the BEPS Inclusive Framework has 137 members. Also, capacity building activities ensure that all the members can benefit from the implementation of these standards. This work must continue and is moving forward, with the implementation of automatic exchange of information being closely monitored and peer reviewed with the final results expected in 2022. This is to ensure it works in practice and globally. In fact, the BEPS Minimum Standards are currently reviewed for possible improvement. Fortunately, more is being done on capacity building thanks to generous donors and the attention of the G20.

On a New Social Contract

Growing inequalities of income, wealth and opportunities are fracturing society economically and socially, thus threatening the stability and sustainability of the Social Contract. For that reason, a new Social Contract must be established, comprising of two elements. On one hand, policies that can protect people against the risks they face and give everyone the opportunity to thrive should be implemented. On the other, measures that can address people’s perceptions and attitudes are necessary in order to build support for these policies. The main areas and levers for action include investment in health; education and skills; social protection; and the promotion of gender equality. In fact, policies that are particularly effective are those which take account the distributional effects and dynamics over the life-cycle for different groups, notably women. Two examples of such measures are the promotion of early childhood education, and the care and access to affordable quality housing. The OECD recently released a report entitled Changing the Odds which highlights the benefits of investing in vulnerable children.

The case for social investment is at the heart of the “Economy of Well-Being” agenda which highlights that investment in well-designed and inclusive social protection schemes can be very effective in protecting individuals, while at the same time delivering better labour market outcomes. Effects can indeed be particularly important for middle class families, which face a higher risk of downward social mobility. However, building the necessary public support to implement these policies will require measures to restore trust and address existing perceptions and attitudes. In fact, the OECD is establishing standards which can help stakeholders restore trust, for example through its Trust in Business initiative and the work on trust in digital environments in the context of its Going Digital project.


[1] OECD Compare your Income Tool

[2] OECD (2019) Under Pressure: The Squeezed Middle Class, Paris: OECD Publishing.

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