Summary

Economic inequality is increasing around the world, with no signs of changing direction. Economist Thomas Piketty asserts that inequality is a fundamental “feature” of capitalism which requires state intervention to address - stoking heated political debates on introducing new “wealth taxes” around the world. Yet administering tax and benefit systems are a costly overhead for governments - introducing another tax in the traditional manner would create yet more complex and costly state machinery to collect and redistribute the proceeds. 

What if instead the machinery of wealth redistribution was built into the monetary system itself? New sovereign digital (crypto-)currencies promise new monetary policy tools which could make the redistribution of income and wealth into a core function of money rather than the state - thus enabling central banks to simply target an “inequality rate” in much the same way as an inflation band or unemployment rate - and reducing the overhead of tax collection and distribution on governments around the world.

Background

Sovereign governments and central banks around the world are beginning to investigate sovereign digital currency instruments. China has stated that its sovereign cryptocurrency is “ready for launch”. The tiny Marshall Islands have announced a plan to create their own “SOV” cryptocurrency which will be legal tender when (if...) it is launched. Meanwhile Estonia’s ambitions for a state-backed cryptocurrency were dashed by the European Central Bank and other developed economy central banks including New Zealand and Australia have ruled out issuing digital currencies any time soon. 

(And as Western economies procrastinate, Facebook has initiated the Libra consortium to launch a global cryptocurrency backed by traditional financial assets and independent of any sovereign government.)

Digital currency issued by central banks would enable national treasuries to make use of all the technological advantages of cryptocurrencies, but without ceding control to nationless, decentralized infrastructure such as Bitcoin, Ether and others. A sovereign digital-/crypto-currency - including a universal transaction ledger - promises to deliver completely new financial infrastructure for all users of money: real-time data collection, low transaction costs, bookkeeping, traceability not to mention the implementation of monetary policy. The potential efficiencies of scale and enhanced functionality of a unified national ledger system are significant.

(It should also be pointed out that introducing state-operated financial infrastructure would require increased oversight and controls - and may be perceived to infringe even further upon individual privacy and human rights than current “anti-money-laundering” / ”financial surveillance” regimes do. This post does not explore the social and regulatory implications further, other than acknowledging their fundamental importance.)

Addressing the inequality challenge

Inequality among the world’s population can take many forms: economic, health, lifespan to name a few commonly invoked dimensions. (Recent efforts have framed the problem as one of improving “wellbeing” for populations as a whole, targeting reductions in inequality across a range of socioeconomic measures. In particular in New Zealand where a basket of non-financial wellbeing measurements now underpin the annual government budgeting process.)

By many measures, economic inequality is increasing around the world. Income inequality within OECD countries is at its highest level for the past half century: the average income of the richest 10% of the population is about nine times that of the poorest 10% across the OECD, up from seven times 25 years ago. Even more startling statistics surround wealth inequality: globally, the richest 1% population own 45% of the world’s wealth.  In the US in 2018, the richest three American men — Jeff Bezos, Bill Gates and Warren Buffett — held combined fortunes worth more than the total wealth of the poorest half of Americans. 

Income and wealth redistribution - the old way

Through taxation, governments around the world engage in income and (to a lesser degree) wealth redistribution to attempt to reduce inequality. Traditional solutions are based upon collection of income taxes and then a range of means-tested benefit distributions. An analysis of all OECD countries’ redistributive policies shows that taxes and transfers redistribute income across all deciles, thereby reducing inequality to some degree. More recently there has been increased interest in novel mechanisms such as (universal) basic income (UBI) as a more effective and simpler redistributive mechanism. 

In reality, the bureaucratic machinery of income redistribution places a significant cost on the state. For example, in New Zealand, the Ministry of Social Development manages over NZ$26 billion of government expenditure, including over NZ$14.5Bn on superannuation (pension) payments and NZ$6.5Bn on benefits and assistance. (Social security and welfare spending makes up a total of NZ$33Bn - nearly 30% of total government spending).

French economist Thomas Piketty’s widely discussed 2014 book Capital in the Twenty-First Century examines the evidence that economic inequality is worsening and proposes taxing wealth as a solution. The central thesis of the book is that inequality is a “feature” of capitalism, and can only be reversed through state intervention.

In line with this, recent political discourse around inequality is starting to turn towards explicitly taxing wealth - US Democratic presidential candidate Elizabeth Warren proposes an “ultra-millionaire tax” based upon 2% of household net worth above US$50 million. Countries including Switzerland, Norway, Netherlands and Argentina all have some form of wealth tax already in place.

Functions of a central bank

In many countries, governance and management of monetary policy is devolved to a central bank (for example the Federal Reserve in the US, European Central Bank in the Euro Area, the Bank of England in the UK). Central banks generally have five main functions:

1. Issuer of currency in circulation (notes and coins)

2. Lender of last resort to banks

3. Lender of last resort to government

4. Ensure the stability of the banking system

5. Set monetary policy, mainly through the control of interest rates. 

While central banks in most developed nations are independent institutions and protected from political interference, monetary policy may be still be set to achieve certain government targets, in particular:

• Keep price inflation within a certain target band

• Economic growth targets

• Unemployment targets

All quite straightforward, at least until the system crashes like in the GFC of 2008 when liquidity crises have required more unconventional monetary policy levers such as quantitative easing - “creating money” and using this money to buy bonds with the aim of reducing interest rates and boosting bank lending.

Sovereign cryptocurrencies - enabling new digital monetary policy levers

Enter sovereign digital-/ crypto-currencies.

Bitcoin, as the original, decentralised and critical mass cryptocurrency relies upon game theory to balance supply and demand for new coins. An energy-intensive “mining” process incrementally releases new bitcoin into circulation, with a theoretical maximum of 21 million bitcoins ever to exist. New bitcoins are created roughly every ten minutes and the rate at which they are generated drops by half about every four years until all will be in circulation. Pseudonymous Bitcoin creator Satoshi Nakamoto effectively set a monetary policy based on artificial scarcity at Bitcoin's inception. 

The lack of flexibility in Bitcoin’s algorithm to massage the money supply up or down (eg to support central bank activities such as quantitative easing) is a criticism of Bitcoin’s infrastructure. Critics argue that a global currency system based upon Bitcoin (or similar) cryptocurrencies would be incredibly brittle in the face of global financial crises. 

For this reason, proponents of sovereign digital-/crypto-currencies argue in favour of new digital money supply which is governed and regulated through more traditional techniques - for example through the central bank deciding to issue more or less currency into circulation, or adjusting the interest rate paid to (extracted from) holders of currency.

So at the very least, monetary policy functions of sovereign cryptos echo those of fiat currencies world wide:

• Controlling money supply

• Setting interest rates

But by virtue of the new financial infrastructure they provide, sovereign cryptos potentially provide a raft of new functionality. For example, central banks could manage lending directly to businesses and individuals, rather than only to commercial banks - thus levelling the playing field and minimising rent taking by commercial banks adding lucrative interest rate margins for little risk.

When considering the inequality question, two other potential functions stand out in particular:

• Automatic, near-zero-cost redistribution of wealth

• Automatic, near-zero-cost redistribution of income

New digital monetary policy function #1: wealth redistribution

As we’ve seen:

• Economic inequality is one of the critical issues of our time, and 

• State intervention through wealth taxes are considered the imminent way to address this.

What if the state function of tax collection and wealth redistribution could instead be delegated to central banks as a monetary policy lever? In the same way as some governments set unemployment targets for their central banks, what if they set “wealth inequality targets”?

Furthermore, what if sovereign digital currency infrastructure could replace much of the bureaucracy of wealth tax collection and redistribution with an automatic algorithm which more evenly distributes wealth across the currency system? 

For example, to implement Senator Warren’s proposed wealth tax - for each “household” in the universal ledger (sum up all the “household wallets”), if the total value of all currency holdings adds up to more than $50 million, remove an annualised 2% from those wallets and redistribute across the rest of the ledger according to “household” wealth. Running the redistributive algorithm across all accounts at a regular frequency (daily? hourly?) would increase precision and fairness.

It sounds simple and elegant - as with the current taxation system, this would need robust legislation to unambiguously define a “household” and map it to the correct wallets on the ledger. More importantly, however, the redistribution would only cover the small portion of total household wealth which is held in currency. 

So, as currently, the tax system would still be needed to calculate all non-currency household assets and map these to the household calculation on the ledger as well. But arguably this automated redistribution infrastructure could be maintained at a fraction of the billions of dollars cost currently spent on state bureaucracies dedicated to tax collection and social benefit distribution.)

(The more fundamental question is whether the rich would choose to hold any of their wealth in such a redistributive currency at all… but then, how is this different to negative interest rates?)

New digital monetary policy function #2: income redistribution

In a similar way to wealth, income redistribution could be automated using sovereign digital currency infrastructure, removing the need for much of the current state infrastructure required for tax collection and redistribution. This may also have the added benefit of unburdening private enterprises from their undesired role as payroll tax collector...

The government of the day sets a clearly defined and legislated  “income equality target” which is then delegated to the central bank to implement as monetary policy.

In practice, each wallet on the ledger participates in many taxable / non-taxable income transactions. Periodically (each day, hour…?), all applicable income transactions would have the relevant taxable amount automatically debited from all wallets on the ledger and automatically redistributed to low-income wallets according to an algorithm optimised for the target set by government.

It seems intuitive that income redistribution would be an easier challenge than for wealth since almost all income transactions are already denominated in fiat currencies and paid digitally. This algorithm is also perhaps easier to apply because the concept of a “household” may not necessarily be required, each wallet being mapped to legal persons or companies.

Another aspect of income redistribution could be the automatic administration of a basic income - when “creating money”, central banks could distribute that money directly across all the individuals in the economy rather than effectively lending it to commercial banks.

Challenges

These two new tools for addressing economic inequality leverage potential new capabilities within sovereign digital currency infrastructure. The greatest potential benefits of these, besides actually reducing wealth and income inequality, would be significantly reducing the administrative cost to the state and increased precision and fairness of the taxation / redistribution systems.

Clearly there would be major challenges to implementation in many countries, including:

• Fundamental legal objections to “theft of property” - where money is framed as immutable asset. But the entire concept of money relies on a collective hallucination of “property” which could be clearly defined in updated legislation.

• Objections to increased state financial surveillance and intrusion on individual privacy

• Digital inclusion - what about members of society not able / willing to participate in novel digital currencies?

• Game theory - unless compelled to do so, why would anyone choose to hold wealth or receive income in a redistributive currency?

• Security of digital currency and redistribution infrastructure and susceptibility to cyber attack

• Risk of “big bang” rollout - perhaps mitigated by incentive-driven participation in pilot projects would support a new redistributive currency system to be introduced gradually

Conclusion

As with many new technology opportunities, China is forging ahead with establishing a next generation of digital currency infrastructure which promises to provide huge efficiencies of scale, performance and resilience for their monetary system. If this initiative is successful, the Chinese central bank will have access to an unmatched pool of transaction data which will enable them to manage their currency with an order of magnitude more precision than before.

Outside China, Western nations are slow to commit to upgrading their digital currency infrastructure. One reason for this may be anticipated objections from civil rights and privacy advocates to resist any further financial surveillance. It may be that private interests, for example the Facebook-led Libra consortium, seize the initiative from governments.

Meanwhile in the West economic inequality remains an ever more crucial political issue. Economists advocate wealth taxes as a solution but Governments will find it hard to gain the mandate to legislate these and costly to put in place the tax collection infrastructure. 

This post has explored the alternative possibility of fundamentally designing income and wealth redistribution systems into the money we use - thus achieving targeted reductions in inequality at a fraction of the cost to the state of introducing and managing wealth taxes.