Income inequality hurts economy, study suggests

Policies that favour the wealthy in the hopethat money will trickle down through the economy do not produce greatergrowthwhileboosting incomes of the poor does expand the economy.

That was one ofthe conclusions of an exhaustive study prepared forthe International Monetary Fundreleased on Tuesday that looked at historical data from 150 developed economies around the world overthe past several decades.

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Although the study looked at many things, one of the key areas examined was income inequality how a country's collective wealth is divided between different income groups.

Trickle-down economicsquestioned

Conventional economic theory in some quarters isthat the best way to stimulate economic growth for everyone is to move capital to the top, where it gets invested inbusinesses that create jobs and tax revenues for all.

Known as trickle-downeconomics, it's thought by some to be a better way to expand the economy than directing wealth to lower income groups lower down, who, according to the theory, don't spend money in ways that filter through the entire economy.

But the discussion paper suggests the numbers don't back up that theory.

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"If the income share of the top 20 per cent [the rich]increases, then GDP growth actually declines over the medium term, suggesting that the benefits do not trickle down," the report reads.

The authors calculated that for every percentage point increase in income share by the richest quintile in any given country studied, GDP growth was 0.08 percentage pointslower in the following five years than it would otherwise have been.

Conversely, if the income of the poorest quintileincreases by one percentage point, the country's economy expands by a little over a third of a percentage point in the ensuing half-decade.

The discussion paper was prepared byEra Dabla-Norris, Kalpana Kochhar, Frantisek Ricka, Nujin Suphaphiphat, and Evridiki Tsounta, with contributions from Preya Sharma and Veronique Salins. A disclaimer on the report makes clear that it is a "staff discussion note" and that theviews expressed in it should be attributed to the authors and not the IMF.

"Staff discussion notes are published to elicit comments and to further debatereflects," the disclaimer says.

Growing gap

"Widening income inequality is the defining challenge of our time," the report notes, echoing recent remarks fromIMF head Christine Lagarde, who is pushingworld leaders to take action on the issue.

The discussion papersuggests thatas the income share of the richest 20 per cent increases, so, too, does their political influence, which leads to what the group calls a "suboptimal" distribution of resources. The richpress for political policies tailored towardthem not necessarily those that would benefit everyone.

When economically disadvantaged people are denied an equal share of economic growth, that gap widens, becausethose on the bottom of the income scale tend to spend a disproportionately larger share of their income on basic needs like health care, education and food. Their spending tends to boosteconomic growth, but when they have less money, it drags down growth overall.

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Policies that favour those higher up the economic ladder "can lead to under-investment in education as poor children end up in lower-quality schools and are less able to go on to college," the report says. "As a result, labour productivity could be lower than it would have been in a more equitable world."

The report also suggestswholesale changes to the way developed economies tax their citizens, moving away from regressive income taxesand towarda more progressive system built onwealth and property taxes, and a crackdown on tax avoidance and evasion.