Investment Strategy:  Third Quarter 2022Inequality Meets Policy

Inequality Meets Policy

In his last article on wealth inequality, our Assistant Investment Manager, Finlay Holland, assessed the current outlook for the three key factors that have driven much of the divergence in wealth over the last 40 years. We outlined that 2 of the 3 factors which enabled the baby boomers to benefit economically look unlikely to bring similar benefit to the current generation and generations to come. This presents challenges to governments to develop effective policies if inequality is to be addressed on any significant scale, beyond the ‘build back better’ or ‘levelling up’ headline grabbers. In this article we will focus on current policies in the UK and US which are looking to reduce the wealth gap.

In the United Kingdom the narrative from our Conservative government has been heavily focused on their plans to develop the regions in the north of England which gave them their majority in the last election. The ‘levelling up’ was blown wildly off course by the pandemic but with mounting pressure on Mr Johnson, he has been particularly keen to re-focus attention onto it as the likely keystone to a possible Conservative party re-election.

Hometown Glory?

Britain is regionally unequal with London and the South East boasting higher wages, literacy rates and life expectancy. Rates of illness and unemployment are also lower and the difference in GDP per person in its richest places compared to its poorest places is the largest of any OECD country. The government is to focus primarily on improving transport and connectivity, promising ‘London style’ public transport systems. However, confusingly the government took the decision to scrap the Birmingham to Leeds leg of HS2, an expensive railway project connecting London with the North.

A white paper published by the government in February also outlines targets for increasing life expectancy, ensuring 90% of children hit set standards in reading, writing and maths; rolling out high speed broadband and regenerating towns and cities to encourage people to feel good about where they live. Devolution of powers is also included in the plans but given the current centralised system in the UK it remains to be seen whether mayors and county authorities will be given the capacity and capability to regenerate their regions given that they aren’t currently able to plan their own transport links.

The plans are ambitious but sadly come with little new cash, some funds are simply replacing cash that used to come from the EU and the general trend is for a redistribution of cash that was historically London centric to be more widely dispersed. Whilst the aspiration is laudable, it seems very ambitious to try and correct something as embedded as regional inequality without some kind of wealth redistribution via tax, especially when the project spans multiple government departments and will require significant skill in policy detail, not to mention an ability to remain steadfast through the inevitable setbacks. This is a very real challenge for political leaders as they seek to balance implementing difficult long-term plans against the nature of an election system where voters often make decisions based on short term success or failure.

Given there is no proposed extra tax to cover the government’s flagship project, it is safe to assume the measures are more long term aspirations to reduce inequality, so what are some of the potentially overlooked measures which could help in the short term?

The Resolution Foundation identify that household wealth has risen from three times national income to over seven times in the last 30 years and that the primary driver of this has been rising house prices. These gains have been hugely unequal with the least wealthy third of households gaining less than £1000 per adult from rising house prices since the turn of the century compared to £174,000 for the wealthiest 10%. Regional differences have also been large with the average gain per adult in London being £76,000 compared to £21,000 in the North East. The situation looks even more bleak for those not on the property ladder yet, with the average age of first time buyers in Britain rising to above 30 in every region (33 in London), and the ratio of median house price to median gross annual earnings in England having risen from 5.1 in 2002, to just over 9 in 2021 (the gap is larger in London & the South East). What’s more, as we addressed in the last article, much of these gains have not been driven by productive choices such as paying off mortgages or making home improvements, but by the global decline in interest rates, making these gains largely unearned. At present capital gains on main residences remain untaxed through the CGT regime and any change would be difficult politically. However, the scale of benefit that homeowners have enjoyed is far beyond what policy makers 30 years ago could have imagined. Furthermore, as we addressed in my previous article, the changing demographic is going to increase taxes regardless and the current status quo would see that through earned income and corporate profits, however for a graduate repaying student loans the marginal rate of tax can rise to 42.25% following the recent introduction of the Health and Social Care Levy. How long such capital gains on main residences can remain off the agenda remains to be seen, but as rising numbers of young voters find it difficult to get onto the housing ladder, there is a possibility that it becomes an increasingly important issue for the voting populous. However, property in the UK is sacrosanct and any sniff of policy that would change the CGT rules on primary residence in this way is certainly not a vote winner in the foreseeable future. It is therefore highly unlikely that this will change, instead, policymakers will likely target different tax environments, such as council tax, to tip the scales.

Salvaging Build Back Better

Across the pond, President Biden is similarly pinning his hopes to a policy with a catchy slogan. ‘Build Back Better’ aims to target a whole host of areas including childcare, education and green energy, to be paid for by increased taxes on the wealthiest Americans and big business. The legislative plan has been in the works for over a year but has yet to be approved by the Senate. The bill has been significantly slimmed down to $1.75tn from the $4tn number which was originally proposed. The infrastructure part of the bill had passed both the House of Representatives and the Senate but the Democrats’ insistence to ensure the social spending be passed with the infrastructure bill has led to significant delay. Included in the bill is $273bn for subsidising demand for childcare, the establishment of a universal pre-kindergarten programme and paid family medical leave. There has also been the expansion of child tax credits which were part of the fiscal stimulus passed in March and have been proven to reduce child poverty. However, Democratic Senator Joe Manchin has raised concerns around the cost of this policy and looks likely to jettison it entirely. With a majority of one in the Senate and every Republican Senator currently rejecting the bill, Mr Biden will find the whole Build Back Better agenda blocked without any movement. The mid-terms may well permanently shelve it if a Republican majority is returned. Furthermore, measures which would have improved social mobility for those already working, such as two years tuition free community college to every American, $80bn on retraining workers and creation of a new scheme for paid family and medical leave have all been blocked thanks to objections by Democratic senators. Proposed spending on higher education and re-training now totals a slender $40bn which is only slightly more than the amount of spending proposed to expand Medicare to include deafness. On the other side of the coin, plans for how to fund this package are scanter than the package itself. Despite ambitions of hitting the 1% where it hurt, Mr Biden’s slim majority in the Senate have meant that plans to increase marginal rates on capital gains and corporate profits have come to little. In place lie a patchwork of policies including a 15% tax on accounting profits for corporations, stock buy-back penalties and a levy of 5-8% on households with income of greater than $10m. Another proposal to eliminate a loophole allowing inherited assets to escape capital gains tax has also been scrapped and a last minute inclusion to the state and local tax (SALT) deduction, which allows those who pay lots of income and property tax at the local and state level to cut their federal tax liability, has had the cap raised by the democrats to $80,000 from $10,000. The result is that the benefit will cost $275bn over the next five years and none of it will go to those in the bottom 60% of the income spectrum. Instead 70% will go to the top 5%. As the package has reduced in size so has the clarity on what it hopes to achieve with most policies targeting social spending being watered down, if not scrapped entirely. With the midterm elections looming this year it looks likely that Mr Biden will either lose his nine-seat majority in the house or the 50/50 stalemate in the Senate to the Republicans, or both. The odds are looking stacked against Mr Biden with Congressional primaries already underway. In the last 25 midterms, the President’s party has lost seats in the House on 22 occasions. Joe Biden’s legacy is threatening the cobwebs of the Congressional archives.

We have only addressed approaches in the US and UK, but inequality is a problem that plagues many economies including China where the ‘common prosperity’ agenda of Premier Xi Jinping remains a key component of their economic plan to curb the excess that many sectors have capitalised on. Looking at our assessments above it does not seem likely any government has thoughtfully grabbed the nettle of wealth inequality with policy packages that will come close to delivering a more level playing field. However, acknowledgement of the problem is widespread, and the pandemic and this most recent bout of high inflation has further highlighted the wealth gap and its disproportionate impacts.

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