HMRC-HMT Economics of Taxation 2011 http://darp.lse.ac.uk/HMRC-HMT

1. 14 December 2011 HMRC-HMT Economics of Taxation 2011http://darp.lse.ac.uk/HMRC-HMT 9.2 Income distribution, taxation and redistribution

2. Overview... Income distribution, taxation, redistribution Income distribution Use US data as a working template Inequality trends Inequality internationally Redistribution

3. 1. Earnings 2. Unemployment compensation 3. Workers’ compensation 4. Social security 5. Supplemental security income 6. Public assistance 7. Veterans’ payments 8. Survivor benefits 9. Disability benefits 10. Pension or retirement income 11. Interest 12. Dividends 13. Rents, royalties, estates & trusts 14. Educational assistance 15. Alimony 16. Child support 17. Financial assistance from outside the household 18. Other income What is income? (1) • Current Population Survey (DeNavas-Walt et al. 2005, 2008)

4. What is income? (2) • Covers money income received • exclusive of certain money receipts such as capital gains • Before deductions • personal income taxes • social security, union dues • Medicare deductions • Does not include noncash benefits • food stamps • health benefits • subsidized housing • goods produced and consumed on the farm • business transportation and facilities, • payments by business for retirement programs. • Examine CPS distributional data…

5. Quantile Incomes by Households More detail. • DeNavas-Walt et al (2005)Table A-3

6. Quantiles: 1967 – 2004

7. The Parade: quantiles vs population

8. Quantile ratios: US 1967 – 2004

9. Overview... Income distribution, taxation, redistribution Income distribution Developments in the USA and UK Inequality trends Inequality internationally Redistribution

10. Mean incomes by groups of households More detail

11. Differential growth of mean incomes

12. 1: The Generalised Lorenz Curve

13. 2: Income shares: US 1967-2004

14. 2: Top income shares in US Source: Piketty and Saez (2003)

15. Top income shares in the UK Source: Atkinson, (2004)

16. 3: Lorenz curve • Natural interpretation in terms of shares • Gives a natural definition of the Gini coefficient

17. UK “Original income” – GLC Note: in December 2005 prices

18. UK “Final income” – GLC Note: in December 2005 prices

19. UK “Original income” – Lorenz

20. UK “Final income” – Lorenz

21. Example 1: Inequality measures and US experience • Source: DeNavas-Walt et al. (2005)

22. Overview... Income distribution, taxation, redistribution Income distribution Comparisons across countries? Convergence? Inequality trends Inequality internationally Redistribution

23. Lorenz around the world… SourceWorld Bank (2004)

24. Income or consumption? SeeWorld Bank (2005), page 38

25. Example 2: International trends • Source: OECD (2011)

26. Example 2: International trends (2) • Break down overall inequality to analyse trends: • I = SjwjIj + Ibetween • can we do this with any inequality measure I? • what weights should we use? • Traditional approach takes each country as separate unit • shows divergence – increase in inequality • but, in effect, weights countries equally • debatable that China gets the same weight as very small countries • New conventional view (Sala-i-Martin 2006) • within-country disparities have increased • not enough to offset reduction in cross-country disparities. • Components of change in distribution are important • “correctly” compute world income distribution • decomposition within/between countries is then crucial • what drives cross-country reductions in inequality? • Large growth rate of the incomes of the 1.2 billion Chinese

27. Inequality measures and World experience • Source: Sala-i-Martin (2006)

28. Inequality measures and World experience: breakdown • Source: Sala-i-Martin (2006)

29. Overview... Income distribution, taxation, redistribution Income distribution Impact of taxes and benefits Inequality trends Inequality internationally Redistribution

30. Another application of ranking • Tax and benefit system maps one distribution into another • c = y T(y) • y: pre-tax income c: post-tax income • Use ranking tools to assess the impact of this in welfare terms • Typically this uses one or other concept of Lorenz dominance • Linked to effective tax progression • T is progressive if c Lorenz-dominates y • see Jakobsson (1976) , Lambert (2001) • What distributional ranking would we expect to apply to these 5 concepts? original income + cash benefits gross income - direct taxes disposable income - indirect taxes post-tax income + non-cash benefits final income

31. Impact of Taxes and Benefits. UK 2006/7. Lorenz Curve • + cash benefits •  direct taxes •  indirect taxes • + noncash benefits • Big effect from benefits side • Modest impact of taxes • Direct and indirect taxes work in opposite directions

32. Impact of Taxes and Benefits. UK 2006/7. GLC • + cash benefits •  direct taxes •  indirect taxes • + noncash benefits • Final income does not second-order dominate original income

33. Implied tax rates in Economic and Labour Market Review • Formerly Economic Trends. Taxes as proportion of gross income – see Jones, (2008)

34. Summary • 2nd-order (GL)-dominance: ranking by cumulations • From lecture 1 • Lorenz dominance equivalent to ranking by shares • Special case of GL-dominance normalised by means • use to characterise redistributional impact • If Lorenz-curves intersect unambiguous inequality orderings not possible • Makes inequality measures especially interesting • Use I-measures to capture effective tax progression

35. References • * Atkinson, A. B. (2004) “Income tax and top incomes over the twentieth century,” Hacienda Pública Española, 168,123-141 • DeNavas-Walt, C., Proctor, B. D. and Lee, C. H. (2005) “Income, poverty, and health insurance coverage in the United States: 2004.” Current Population Reports P60-229, U.S. Census Bureau, U.S. Government Printing Office, Washington, DC. • DeNavas-Walt, C., Proctor, B. D. and Lee, C. H. (2008) “Income, poverty, and health insurance coverage in the United States: 2007.” Current Population Reports P60-235, U.S. Census Bureau, U.S. Government Printing Office, Washington, DC. • Jakobsson, U. (1976) “On the measurement of the degree of progression,” Journal of Public Economics, 5, 161-168. • * Jones, F. (2008) “The effects of taxes and benefits on household income, 2006/07,” Economic and Labour Market Review, 2, 37-47. • Lambert, P. J. (2001) The Distribution and Redistribution of Income (Third ed.). Manchester: Manchester University Press. • OECD (2011)Divided We Stand: Why Inequality Keeps Rising OECD iLibrary. • Piketty, T. and E. Saez (2003) “Income inequality in the United States, 1913-1998,” Quarterly Journal of Economics, 118, 1-39. • Sala-i-Martin, X. (2006) “The world distribution of income: Falling poverty and ... convergence, period”, Quarterly Journal of Economics, 121 • The World Bank (2004)2005 World Development Report: A Better Investment Climate for Everyone. Oxford University Press, New York • The World Bank (2005)2006 World Development Report: Equity and Development. Oxford University Press, New York