Tag: redistribution

Income inequality has been growing in most high-income countries around the world. How much do the redistribution policies of government hold down this growth in inequality? The OECD has published Divided We Stand: Why Inequality Keeps Rising. (The report can be read for free on-line with a slightly clunky browser, and a PDF of an \”Overview\” chapter can be downloaded.) Chapter 7 of the report discusses \”Changes in Redistribution in OECD Countries Over Two Decades,\” which basically means from the mid-1980s to the mid-2000s. The chapter draws on a longer background paper that is freely available on-line: Herwig Immervoll and Linda Richardson\’s paper, \”Redistribution Policy and Inequality Reduction in OECD Countries: What Has Changed in Two Decades?\”

The United States does relatively little redistribution in comparison with other OECD countries. This graph from the \”Overview\” of the OECD report compares the inequality of market incomes to the inequality of disposable income after taxes and benefit payments. Inequality is measured by a Gini coefficient. For a more detailed explanation of how this is measured, see my November 1 post on Lorenz curves and Gini coefficients. But as a quick overview, it suffices to know that a Gini coefficient measures inequality on a scale from zero to 1, where zero is perfect equality where everyone has exactly the same income and 1 is perfect inequality where one person has all the income. The United States has one of the most unequal distributions of market income and of disposable income, and in this comparison group, U.S. policy does relatively little to reduce the disparity. The OECD writes: \”Public cash transfers, as well as income taxes and social security contributions, played a major role in all OECD countries in reducing market-income inequality. Together, they
were estimated to reduce inequality among the working-age population (measured by the Gini coefficient) by an average of about one-quarter across OECD countries. This redistributive effect was larger in the Nordic countries, Belgium and Germany, but well below average in Chile, Iceland, Korea, Switzerland and the United States (Figure 9).

Any economy that has a progressive tax code and benefits for those with low incomes will find that as inequality increases, redistribution will also increase automatically as a result of these preexisting policies Some countries may also take additional steps, when faced with rising inequality of market incomes, to raise the amount of redistribution. A table in Ch. 7 of the OECD report calculates how much of the increase in increase in market incomes from the mid-1980s to the mid-2000s was offset by a rise in redistribution.

Denmark is the extreme case: increased redistribution from the mid-1980s to the mid-2000s offset more than 100% of the rise in inequality of market incomes. In a number of countries, the rise in redistribution offset from 35-55% of the rise in inequality of market incomes over this time period: Australia, Canada, West Germany, Netherlands, Norway, Sweden. By comparison, in the U.S. the rise in government redistribution from the mid-1980s to the mid-2000s offset just 9% of the rise in market inequality.

It\’s useful to look at redistribution policies both from the tax side and the benefits side. The striking theme that emerges is that in most countries, benefits for those with low incomes are much more important in reducing inequality than are progressive tax rates.

On the tax side, the U.S. tax code is already highly progressive compared with these other countries. The OECD published at 2008 report called \”Growing Unequal: Income Distribution and Poverty in OECD Countries, which states (pp. 104-106): \”Taxation is most progressively distributed in the United States, probably reflecting the greater role played there by refundable tax credits, such as the Earned Income Tax Credit and the Child Tax Credit. … Based on the concentration coefficient of household taxes, the United States has the most progressive tax system and collects the largest share of taxes from the richest 10% of the population. However, the richest decile in the United States has one of the highest shares of market income of any OECD country.After standardising for this underlying inequality … Australia and the United States collect the most tax from people in the top decile relative to the share of market income that they earn.\”

This finding is surprising to a lot of Americans, who have a sort of instinctive feeling that Europeans must be taxing the rich far more heavily. But remember that European countries rely much more on value-added taxes (a sort of national sales tax collected from producers) and on high energy taxes. They also often have very high payroll taxes to finance retirement programs. These kinds of taxes place a heavier burden on those with lower incomes.

In addition, top income tax rates all over the world have come down in recent decades, and the U.S. top rate is near a fairly common level. From the \”Overview: \”Top rates of personal income tax, which were in the order of 60-70% in major OECD countries, fell to around 40% on average by the late 2000s.\” From the
Immervoll and Richardson working paper: \”Reductions in top [personal income tax] rates were steepest in Japan (from 70 to 37 percent), Italy (65 to 43), United Kingdom (60 to 40), and France (65 to 48). The flattening of schedules mostly concerned higher income ranges (Australia, Austria, Finland, France, Germany, Japan, United Kingdom, United States).\”

The real difference in how much redistribution affects inequality arises from differences in benefits. The OECD writes: \”Benefits had a much stronger impact on inequality than the other main instruments of cash distribution — social contributions or taxes. … The most important benefit-related determining factor in overall distribution, however, was not benefit levels but the number of people entitled to transfers.\” This theme applies to a number of benefit programs, including disability payments. But here is an illustrations with regard to unemployment insurance, taken from the Immervoll and Richardson working paper. They write: \”Figure 11 indicates that the shares of unemployed reporting benefit receipt have dropped in a majority (two thirds) of the countries shown, while only a few recorded significant increases.\” Notice that the share of the unemployed in the U.S. who get unemployment benefits is on the low end of the spectrum.

This pattern also fits with my post on November 1 about a Congressional Budget Office report which found that Federal Redistribution is Dropping. It pointed out that the share of federal redistribution spending programs going to the elderly has been steadily rising, while the share going to the non-elderly poor and near-poor has not been rising. The working paper also notes: \”[O]ver time, almost all countries devoted declining shares of total spending to cash benefits that mostly benefit children and working-age individuals.\”

The OECD report been criticized for suggesting that higher taxes on those with the very highest incomes might be worth considering, but this is certainly not the main focus of the report. Indeed, given that the U.S. tax system is already one of the most progressive, this recommendation seems aimed more at other countries than at the United States. The \”Overview\” of the OECD report states: \”However, redistribution strategies based on government transfers and taxes alone would be neither effective nor financially sustainable. First, there may be counterproductive disincentive effects if benefit and tax reforms are not well designed. Second, most OECD countries currently operate under a reduced fiscal space which exerts strong pressure to curb public social spending and raise taxes. Growing employment may contribute to sustainable cuts in income inequality, provided the employment gains occur in jobs that offer career prospects. Policies for more and better jobs are more important than ever.\” In particular, the OECD report emphasizes as policy tools to fight unemployment job-related training and education, continuing education over the work life, and reforming rules prevalent in many countries that separate the workforce into temporary and permanent employment contracts.

As part of an overall plan to get the budget deficit under control, and given the rise in inequality over recent decades, I would be favor a somewhat higher marginal tax rate on those with very high income levels. But it seems to me that U.S. political discourse has focuses way too much on taxing the rich. Hard-core Democrats and Republicans both like the familiar arguments over taxes: it gets their blood pumping and their base motivated. But U.S. political discourse has far too little about reforming labor markets to open up more jobs, or about how to stimulate job-related education for life. And neither party stands up for raising government spending in ways that would affect those with lower income levels more, whether through income payments to families (especially to the working poor) or through spending on public goods like neighborhood safety (police, lighting and activities), parks and libraries, or education and public health that would have a greater effect on the quality of life for those with lower incomes.

This is the second of three posts on the recent Congressional Budget Office Report \”Trends in the Distribution of Household Income Between 1979 and 2007.\”  The first post on Incomes of the Top 1% is here, while the third explains the concepts of the Lorenz Curve and the Gini Coefficient.

The federal government can redistribute income in two ways: by taking those with high incomes relatively more, and by making transfer payments to those with lower income. Using the Gini index (explained in the third post in this grouping) as a measure of inequality, CBO reports: \”The dispersion of after-tax income in 2007 is about four-fifths as large as the dispersion of market income. Roughly 60 percent of the difference in dispersion between market income and after-tax income is attributable to transfers and roughly 40 percent is attributable to federal taxes.The redistributive effect of transfers and federal taxes was smaller in 2007 than in 1979 …\”

Redistribution through federal taxes

Here are three figures showing average federal tax rates paid by the top 1% of the income distribution in each year from 1979 to 2007, by the 81st to 99th percentiles, the 21st to 80th percentiles, and the lowest 20%. The first graph shows average payments as a share of income for individual income tax, the second shows payroll taxes, and the third shows all federal taxes combined. Here are a few patterns that jump out.

• The top 1% pays more of its income on average in income taxes, but much less in terms of payroll taxes. Of course, this is the income on which Social Security payroll taxes must be paid is  capped, so such taxes are a smaller share of income for those with very high incomes. 
• With income taxes, the lowest quintile pays on average a negative tax rate: that is, with refundable tax credits, they receive more from the federal government through the tax code than they pay. 
• Total taxes paid as a share of income have dropped off somewhat for all groups in the last decade or so; if one looks back to the mid-1990s, the drop in tax rates for the top 1% looks larger than for other groups.
• The overall patterns here seem to be that the federal tax code as a whole became less progressive in the 1980s, more progressive in the 1990s, and since then has either not changed or become slightly less progressive, depending on what statistical measure one chooses to emphasize.

These sorts of graphs always turn my mind to Warren Buffett, and his claim that he pays less in taxes than his secretaries. For example, see Buffett\’s August 14 article, \”Stop Coddling the Super-Rich,\” in the New York Times, where he writes: \”Last year my federal tax bill — the income tax I paid, as well as payroll taxes paid by me and on my behalf — was $6,938,744. That sounds like a lot of money. But what I paid was only 17.4 percent of my taxable income — and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent.\”
What Buffett pays as a share of income sounds plausible to me: he is well-known for taking a fairly small annual salary and then receiving most of his income in the form of gains from his investments. Because many of the investments have been held for long periods of time, they are subject to a lower capital gains tax rate. But the tax burdens that Buffett claims for his staff look unrealistically high. Let\’s say his office staff are in the 81st-99th percentiles of the income distribution. Average tax rates for that group are in the range of 22-23% in recent years. Buffett\’s staff might face a marginal tax rate might be 36% or 41%, depending on rules bout phase-outs of deductions and the like. But if Buffett\’s staff really are paying an average federal tax rate of 36% as a share of total income, they need access to better accountants or tax lawyer. 

 Redistribution through federal transfer payments

Federal government transfer payments are about 10-12% of household market income from 1979 to 2007. Spending in this category is heavily driven by Social Security and Medicare. In recent years, about half of federal transfer spending is Social Security. A third is health-related programs like Medicare and Medicaid. The rest is programs like unemployment insurance and welfare.

The share of federal transfer spending on the elderly is rising. In 1979 about 62% of all federal transfer payments went to elderly childless households, while about 19% went to nonelderly childless households and another 19% to households with children. By 2007, 69% of all federal transfer payments went to elderly childless households. The share going to nonelderly childless households stayed about the same, and the share going to households with children fell to about 11%.

Of course, Social Security and Medicare are not means-tested programs, so as they took a larger share of the federal transfer pie, the share going to the poor declined. Not coincidentally, back in 1979 about 54% of federal transfers went to households in the lowest quintile of income; by 2007, only about 36% of federal transfers went to households in the lowest quintile of income.

Summing up the redistribution by federal taxes and transfers
Here\’s a final figure showing how federal transfers and taxes affect income inequality, which is measured by the percent amount that these policies reduce the Gini index of inequality. The extent to which these policies reduce income inequality dropped in the 1980s, rose in the early 1990s, dropped in the late 1990s, rose in the early 2000s and has fallen since then. Interestingly, the diminished effect of federal redistribution since the mid-1990s is, by this measure, much more traceable to the changes in transfer payments than to the changes in progressivity of taxes.