The gap between rich and poor in advanced economies is now at its highest level in decades.

The International Monetary Fund (IMF) warns the yawning gap of income inequality is the “defining challenge of our time”.

In a new report, the IMF says that when income share increases in the top 20 per cent of households, economic growth “actually declines” over the medium term.

“The benefits do not trickle down,” the IMF says.

Conversely, it finds an increase in the income share of the bottom 20 per cent of households is linked with higher GDP growth.

The report, Causes and Consequences of Income Inequality: A Global Perspective, argues that both income inequality and income distribution can influence economic growth.

This is a significant shift in the IMF’s official stance from decades past.

The analysts say income inequality in advanced economies has become so bad that policymakers “need to focus on the poor and the middle class” if boosting economic growth is the plan.

The report follows-on from a study last year, which found that growing income inequality in the middle and lower income bands retarded economic growth.

“Our findings suggest that raising the income share of the poor and ensuring that there is no hollowing-out of the middle class is good for growth,” the new report says.

“Fiscal redistribution, carried out in a manner that is consistent with other macroeconomic objectives, can help raise the income share of the poor and middle class, and thus support growth.”

The report says policymakers should inject their fiscal policies with “greater reliance on wealth and property taxes”.

This should be accompanied by cuts to tax expenditures that benefit high-income groups the most, and the removal of tax relief – low taxation of capital gains, stock options, and carried interest – to “increase equity and allow a growth-enhancing cut in marginal labour income tax rates in some countries”.

In Australia, economists have argued that Australia's capital gains tax and negative gearing regimes have contributed to Sydney’s wildfire property market.

The Grattan Institute's John Daley and the Bank of America Merrill Lynch's Saul Eslake are two of the most prominent voices in the push to reform capital gains tax.

The new IMF report also says international moves to weaken labour unions, and the subsequent relaxation of labour regulation, is part of the reason that the top 10 per cent of households in some advanced economies enjoy a higher income share.

The findings on labour unions - which are set to be published in an upcoming report - likely reflect the fact that “labour market flexibility benefits the rich and reduces the bargaining power of lower-income workers,” the IMF says.