KUALA LUMPUR: Progressive taxes and social transfers such as targeted handouts can be very effective in reducing income inequality, provided they are enforced under an effective democracy, said a World Bank economist.

Speaking at the forum on cost of living in Malaysia last Friday, economist Ndiame Diop pointed out that developed countries such as Sweden and Norway have successfully addressed wide income gaps — as indicated by the Gini coefficient — through the implementation of such policies.

In a nutshell, a high Gini coefficient means there is higher income inequality, and vice versa.

“The notion that Nordic countries are very equal has a lot to do with the quality of the government policy, the quality of social transfers and protection, the effectiveness of the tax system and public expenditure which helps the poor and benefits them.

“Not many people know that if you calculate the gap between the rich and the poor at market income level (wages before tax and social security transfers), Sweden would be a very unequal country,” said Diop.

“But once you add [social] transfers to the poor and progressive taxes [that tax the rich more], then the Gini coefficient will become very low,” he added.

These measures, said Diop, include direct subsidies, cash handouts, and government spending on things that can be utilised by the low-income groups — sometimes for free — such as education and health.

He also highlighted the “direct link between cost of living and corruption”, as the latter affects whether public money allocation serves its purpose or is wasted on leakages.

“[But] I am very glad to see that in Malaysia, democracy is working,” Diop said, pointing to how Malaysians have used democracy as a tool to impose checks and balances on the government.

“Effective democracy is a very good way to impose quality of spending, which is crucial in addressing cost of living as seen in how it works in some countries,” he added.

He, however, pointed to how many emerging economies such as Malaysia and Indonesia have done “very little” to reduce the income gap after implementing various measures.

Diop opined that the reasons include quality of implementation of government policies. “[The Nordic countries] are really very, very good at making sure that every dollar spent on public budget goes where it has to go.

“We find that in Indonesia the progressive tax system is undermined by [the fact that] many of the rich do not pay their share of taxes,” he said.

“In the case of Malaysia, it was relatively similar with what was seen in Indonesia, which gives room for improvement [to tighten the policies],” he added.

Diop pointed to how the rich in Malaysia and Indonesia benefit from poorly targeted social transfers, citing examples such as fuel subsidy practised by governments including in Malaysia.

While cost of living woes are not unique to Malaysia, Diop pointed to how prices of food in the country rose 31%, nearly twice as fast compared to other indicators in the consumer price index between 2010 and 2018, citing data from the Department of Statistics.

Moreover, Bank Negara Malaysia data showed housing prices increased drastically, at 26.5%, compared to income growth of 12.4%, between 2012 and 2014, he said.

In the long run, he said policymakers should focus on growing the average income of Malaysians by focusing on overall productivity, adoption, and diffusion of technology and taking into account the future of work, particularly for the B40 income group.