Financial Inclusion

3 Ways Investors Are Addressing Income Inequality

The share of income going to the top earners in America has been climbing for decades, resulting in divides between people at different income levels. In 2015, the top 1% of earners had an average income 26.3 times higher than that of the bottom 99%. Some social justice advocates believe that such large disparities are unjust and run contrary to the ideal of equal opportunity. Others argue that if society doesn’t take action to correct the causes of income inequality, polarization could threaten economic infrastructure and hold back growth.

In a new report, The Investment Integration Project (TIIP) and the Principles for Responsible Investment (PRI) explore three key areas where investors who are concerned about income inequality can address this social issue.

Labor Rights

As union membership falls, workers find it more difficult to win wage increases and improvements in working conditions. Princeton economist Alan Kreuger has identified the decline in workers’ bargaining power to be among the causes of income inequality. For this reason, some believe that it’s up to investors and governments to ensure that workers don’t fall behind economically. TIIP and PRI recommend that investors support minimum wages and policies that are favorable to collective bargaining; the report also advises engaging with companies to set labor standards and fair wage practices for supply chains.

Although it’s widely accepted that workers should be safe and respected on the job, there are potential objections to specific policies meant to protect workers. The first is cost: higher wages and stronger employee rights could impose a financial burden on companies, possibly hindering their ability to grow and innovate. The report acknowledges this factor, advocating for a balance between savings and labor rights.

In addition, some have claimed that pro-labor policies could have unintended negative consequences. For example, a Labour Economics study of Japanese companies found an association between higher minimum wages and a reduction in formal job training. Similarly, a report on long-run unemployment rates in Europe raised the possibility that regulations protecting workers might contribute to more rigid labor markets in which employers are less willing to hire new employees; at the same time, it noted that evidence shows that the results of employee protection legislation may be ambiguous.

Taxation

Still a contentious issue, raising taxes on the highest-earning members of society has long been advocated as a way to reduce inequality. This was one theme of the Occupy Wall Street movement in the aftermath of the 2008 financial crisis, and it was more recently supported by the International Monetary Fund.

That said, counterarguments abound. Writing in the New York Times, economist Deirdre McCloskey has argued that redistributive taxation “reduces the size of the crop,” hurting the economy overall, and that it’s better to promote economic growth to raise living standards. Others have pointed out that some of the states with the most progressive income tax systems have especially high levels of income inequality, suggesting that raising the top marginal tax rate is not an easy fix.

Although inequality receives frequent media attention, there’s disagreement about how much inequality has gone up, how to measure it, what an ideal income distribution would be, and which policy responses are appropriate.

The position of TIIP and PRI is that taxes are a form of social responsibility; tax revenues are necessary to fund public services and maintain a sustainable business environment. According to this view, attempts to minimize taxes owed can undercut firms’ long-term profitability because they exacerbate the causes of income inequality and destabilize society. The report recommends that investors support public policies that thwart tax evasion, in addition to pressing companies to disclose overly aggressive tax strategies and to heed the regulatory risks of tax sheltering.

CEO Compensation

The gap in pay between executives and rank-and-file workers is for many a stark symbol of inequality, and some advocate for narrowing it. The idea has its detractors, though. It’s been argued that executives make an outsized contribution to firm success and should be compensated accordingly, and that scrutiny of the CEO-to-worker pay ratio encourages misleading comparisons between firms in different industries and markets.

Still, dissatisfaction with the status quo on executive pay hasn’t gone away. The Economic Policy Institute has estimated that CEO pay rose more than 800% between 1978 and 2016, while average worker compensation went up only about 11%. If that matters for firms’ financial success, it could be because research has suggested that a high pay ratio not readily explained by economic factors is often followed by a drop in firm performance, possibly because employees feel demoralized.

The report recommends that investors reevaluate compensation incentives that tie CEO pay to short-term financial targets like stock prices. According to TIIP and PRI, investors should ask companies to expand their reporting on environmental, social, and governance (ESG) factors and to change their executive pay model so that it takes into account employees and other stakeholders.

Although inequality receives frequent media attention, there’s disagreement about how much inequality has gone up, how to measure it, what an ideal income distribution would be, and which policy responses are appropriate. Unless trends in wage disparity data reverse, these debates are only likely to intensify. It’s now up to investors to decide where they land on this issue and which anti-inequality measures, if any, they want to pursue.

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