Reforms Reducing Income Inequality and Poverty Martin GUZI martin.guzi@econ.muni.cz What to learn •Study materials •https://ourworldindata.org/income-inequality •Learn and practice to construct Lorenz Curve and to calculate Gini index • http://shlegeris.com/gini •Understand principles of participation income •https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1467-923X.1996.tb01568.x •(pdf uploaded to study material folder – 3 pages) Income Inequality gets media attention •Inequality: The rich and the rest •Income inequality: Rich and poor, growing apart •Financial inequality: Are the rich making you poor? •Globalisation and the rise of inequality •Poverty wages in the land of plenty •Income Gap Grows Wider (and Faster) •Richest 8 boast same wealth as half the world (2017) • • • • In April 2014 Pope Francis tweeted: “Inequality is the root of social evil". http://www.theguardian.com/business/2014/mar/17/oxfam-report-scale-britain-growing-financial-inequa lity Figure 1: Wealth of the Four Main Mexican Multimillionaires as a Percentage of GDP INEQUALITY INCOME AND POVERTY IN MEXICO • https://blogs.lse.ac.uk/government/files/2017/03/Fig-1-1024x743.png https://blogs.lse.ac.uk/government/2017/03/24/inequality-in-mexico-and-how-to-address-it/ Income inequality in rich countries Top 1% income share •The share of income earned by top 1 percent (super rich) is a good fit of overall inequality in the country •In Germany top 1% earns more than 150,000 EUR •In 2014-15 UK top 1% earns more than £150,000 (top 5% earns more than £70,000) •In 2017 Canada top 1% threshold is 236,000 CAN •In the US the annual income of $700,000 (2023) $422,000 (2015) opens the door the top 1% club ($389,000 in 2011). The average income earned by top 1% is $1,3 million that is 26 times higher than average income $50,000 of bottom 99%. • • UK: https://www.theguardian.com/money/2017/apr/19/how-much-earn-rich-70000-labour https://www.gov Canada: https://www150.statcan.gc.ca/t1/tbl1/en/tv.action?pid=1110005501 US 2015 wage data https://www.epi.org/multimedia/unequal-states-of-america/ https://www.epi.org/publication/the-new-gilded-age-income-inequality-in-the-u-s-by-state-metropolit an-area-and-county/ https://www.cnbc.com/2023/09/30/how-much-money-you-need-to-make-to-be-in-the-top-1-percent-in-every -state.html • Top income inequality is measured as the share of total income that goes to the income earners at the very top of the distribution. Usually the top 1%. Historical top income inequality estimates are reconstructed from income tax records, and for many countries these estimates give us insights into the evolution of inequality over more than 100 years. https://www.epi.org/multimedia/unequal-states-of-america/ To be in the top 1 percent nationally in 2015, a family needed an income of $421,926. The highest thresholds were in Connecticut ($700,800), New Jersey ($588,575), New York ($550,174), and California ($514,694). In New Mexico, you need $255,429. Overall in the U.S., the top 1 percent took home 22.03 percent of all income in 2015. Share of income captured by the top 1% varies between states in the U.S. https://www.epi.org/multimedia/unequal-states-of-america/ • • • https://ourworldindata.org/wp-content/uploads/2018/07/Top-Incomes-750x536.png Lopez-Calva and Lustig (2010) suggest that the main factors contributing to declining inequality in Latin countries are i)a decrease in the earnings gap between skilled and low-skilled workers and ii)an increase in government transfers to the poor. Summary •Income inequality has been rising over the last decades, but magnitudes are very different between countries. •A universal trend of increasing inequality is determined by global market forces and technological progress. Political forces on the national level are important for how incomes are distributed. The different inequality trends within countries suggests that the institutional and political frameworks are important in shaping inequality of incomes. • A picture containing table Description automatically generated Do you choose option 1 or option 2? 1. You can choose the decile you are to be born in, but not the country. 2. You can choose the country you are born and live in, but not the decile. https://jackblun.github.io/Globalinc/html/fig_2014.html The most important determinant of your income is the country. • https://ourworldindata.org/wp-content/uploads/2013/12/inequality-of-incomes-before-and-after-taxes- and-transfers.png Redistribution through tax and welfare contributions is high in Germany (top 10 richest taxpayers contribute about 50 percent of income tax). 20:20 ratio and inequality The many ways to measure income inequality •Share of income (top 10%, 1%, .1%, .01%) •Gini index –The range of the Gini index is between 0 and 1 (0% and 100%), where 0 indicates perfect equality and 1 (100%) indicates maximum inequality. •20:20 Ratio (or decile ratio can be used) –Compares how much richer the top 20% of populations are to the bottom 20% (SE=4,UK=7,US=8) •Palma ratio (the ratio of the income share of the top 10% to that of the bottom 40%). •Other: the Robin Hood index, the Atkinson index and Theil index. • https://data.oecd.org/inequality/income-inequality.htm Corrado Gini died in Rome on 13 March 1965, he could not have known that 50 years on, the UN would still use his name in their annual rankings of nations. Gini developed his coefficient in 1912, building on the work of American economist Max Lorenz. https://ourworldindata.org/wp-content/uploads/2013/12/Gini-measure-schematic-1-703x550.png https://files.transtutors.com/book/qimg/7508cd60-8f70-4cdb-8838-5d57904654d1.png The more curved, the more unequal Gini Calculator: http://shlegeris.com/gini https://www.bbc.com/news/blogs-magazine-monitor-31847943 But the Gini coefficient also has limitations. For one, it takes all the data from the Lorenz curve and converts it to a single number. Two different income distributions can have the same Gini coefficient, and a lot of information is lost in the conversion to a graph. Cowell asks, "Why not just look at the Lorenz curve?" Compare Gini of two economies 1.In the first economy half of the households have no income, and the other half share income equally. 2. 2. 2.In the second economy there is a complete income equality, except for one wealthy household that has half the total income. Discuss how Gini is affected by 1.Size of country (large vs small) 2.Population demography 3.Child benefits (fixed amount) given to every family with children Limitations of the Gini index 1.Income concept matters A Gini based on individual incomes is different to a Gini based on household incomes. 2.Gini depends on reliable income data Shadow economies and informal economic activity are not included (developing countries). 3.Gini is sensitive to outliers—a few very wealthy or poor individuals can change the statistic significantly, even in a large sample. 4.Gini index is a relative measure (absolute income does not matter) 5.Demographics matters (pensioners push Gini up) 6.Very different income distributions can result in identical Gini (use Lorenz curve) 20:20 ratio (countries ordered by Gini) •The 20:20 or 20/20 ratio compares how much richer is the top 20% of a population to the bottom 20% of the given population. In Czechia the richest 20% only earn 4 times the poorest 20%. http://www.oecd.org/social/income-distribution-database.htm Income distribution data refer to the total population and are based on equivalised household disposable income, i.e. disposable income adjusted for household size. The Gini coefficient takes values between 0 (where every person has the same income), and 1 (where all income goes to one person). The S80/S20 income share ratio refers to the ratio of average income of the top 20% to the average income of the bottom 20% of the income distribution. The poverty threshold is 50% of median disposable income in each country. The income-based poverty rates exclude lump-sum payments which are frequent in the retirement schemes of some countries (e.g. Australia, Switzerland). Working poor are those with income below the poverty line, living in households with a working age head and at least one worker. How much richer are the richest 20% than the poorest 20%? www.equalitytrust.org.uk Source: Wilkinson & Pickett, The Spirit Level (2009) Slide08.jpg Slide09.jpg Inequality in selected countries, 2010 Based on equalized household disposable income (after taxes and transfers). Inequality in selected countries, 2010 Based on equalized household disposable income (after taxes and transfes). •Three key measures of economic inequality: –1. Inequality of income (based on individual earnings data) –2. Inequality of consumption –(based on individual expenses data) –3. Inequality of wealth – –Q1: Which inequality is the most difficult to calculate because of data availability? –Q2: Which inequality is likely to be the highest/lowest (when calculated with data covering the same population)? How does income inequality differ from consumption inequality? consumption-vs-income-inequality-wb https://ourworldindata.org/income-inequality/#how-does-income-inequality-differ-from-consumption-in equality As can be seen, consumption inequality in almost all countries is lower than income inequality. This is intuitive, since consumption can be smoothed over time, for example, by saving earned income. In principle, saving and borrowing allows agrarian societies to have consumption levels that are less volatile – and less reliant on seasonal variation – than incomes.^8 Saving and borrowing is usually harder at low income levels; so consumption and income measures of inequality tend to be closer for poor populations. But as opportunities for saving and borrowing increase, important differences emerge. The following visualization shows that in middle-income countries differences are indeed substantial. •Income inequality isn’t going to go away, and it probably will get worse. Only policies that directly address the problem — in particular, progressive taxation — can help us change course. • Thomas Piketty • Progressive vs Regressive Tax System Progressive vs Regressive Tax System •Take an example of a person earning $70,000 per annum, then his/her tax liability under the progressive tax system is as follows: •The first $10,000 at 10% = $1,000 •The second $10,000 at 15% = $1,500 •The third $10,000 at 20% = $2,000 •The forth $10,000 at 25% = $2,500 •The fifth $10,000 at 30% = $3,000 •The excess of $20,000 at 35% = $7,000 •The total tax liability will be $(1,000+1,500+2,000+2,500+3,000+7,000) = $17,000 •The total tax liability is $17,000 on a taxable income of $70,000. This implies that the average tax rate will be $(17,000/70,000) = 24.3%. From the calculations, it is evident that the average tax rate of 24.3% is less than the marginal rate of 35%. Progressive taxation •Additional tax revenue helps government to finance redistribution •Top marginal rate of taxation, corresponds to the tax rate that applies to the last dollar of income earned by the rich. •Personal income taxes should be made more progressive, with a maximum rate of 65 percent (suggested by Sir Tony Atkinson). • •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. • Warren E. Buffett, 2011 https://www.nytimes.com/2011/08/15/opinion/stop-coddling-the-super-rich.html •New Book by Saez and Zucman provides the most comprehensive estimates of income in the US: -In 2018 the average annual income of Americans was $75,000 (before tax and transfers) -Working class (bottom 50%, 122m) earns $18,500 -Middle class (next 40%, 100m) earns $75,000 -Upper middle class (9%, 22m) earns $220,000 -Rich class (1 %, 2.4m) earns $1.5m • •The average income tax is 28% -Working class pays 25% income tax -Middle class pays bit more -Upper middle class pays at around 28% -Rich pay at around 30% -400 richest Americans pay 23%. Image result for The Triumph of Injustice: How the Rich Dodge Taxes and How to Make Them Pay https://taxjusticenow.org/#/ A close up of a map Description automatically generated A close up of a map Description automatically generated Until 1920 tax revenues were low across all these countries. Less than 10% of national income was collected through taxation (enough to maintain order and enforcing property rights). After the WWI, taxation started growing considerably. In the period 1920-1980 taxation as a share of national income increased drastically, more than doubling across all these countries. •Personal income tax rates United States Finland Germany A B C Q1: Which country has the least progresive tax system? Q2: The highest marginal tax rate? Cap on executive pay •The principle to govern the spread of pay between top and bottom •Swiss executive pay referendum, 2013 –Proposal to limit executive pay to 12 times that of the lowest paid (companies listed on the stock market) –Voters rejected the proposal with a majority of 67.9% (with 46% turnout) – • • • •Book by Tony Atkinson (2015) presents concrete proposals aimed at reducing income inequality 1.Progressive income tax 2.Increase in minimum wage 3.Universal Child Benefit 4.Participation Income Image result for Atkinson’s book Inequality: What Can Be Done? Progressive income taxation •Additional tax revenue helps government to finance redistribution •Initial rate of 25%, intermediate rates of 35-55%, and a top rate of 65%. •Low-incomes tax only 20% Participation Income •Universal (unconditional) basic income is big •Participation income is paid conditional on social contribution. •Paid to adults meeting a participation condition, that includes formal work, but also unpaid work such as caring for a child or an adult, seeking job training, doing voluntary work and include those unable to work. •Proposed by Tony Atkinson already in 1990s https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1467-923X.1996.tb01568.x Situation in the communist countries before the fall of Iron Curtain •The defining characteristic of socialist countries was state ownership of the means of production. •On average, 90 percent of the labor force was employed by the state and most income was paid by the state. •All land was typically owned by state (Russia). •In some countries private agriculture was allowed (Poland, Yugoslavia, Bulgaria and Hungary). State employment as a proportion of the labor force in 1988 [%] Composition of Gross Income in Socialist, Market, and Developing Countries, 1980s • Composition of income, 1988 (gross income=100) the composition of household income in socialist countries before the transition. Countries are arranged, from left to right, in the order of the increasing importance of private sources in total gross income.1 At one end of the spectrum is Czechoslovakia, where an almost total “socialization” of agriculture and severe restrictions on non-agricultural private business meant that only a small fraction (5 percent) of total income was not received through state mediation. In the Soviet Union, approximately 14.4 percent of gross income was derived from private sources. In Bulgaria, Hungary, Yugoslavia, and Poland, the private income share was greater than 20 percent. Labor income—virtually all of it derived from the state—ranged from 53 percent of total gross income (in Poland) to 72 percent (in the U.S.S.R.). Social transfers ranged between 13 percent (Yugoslavia and the U.S.S.R.) and 25 percent (Czechoslovakia) of gross income. Communist economies •Absence of property incomes •Small gaps between average pay of non-manual and manual workers •Low direct taxes (proportional or flat tax) •But total tax burden was high •Greater importance of income redistribution •High family allowances relative to wages •The Gini coefficient was in the range of 23-26 like in the very egalitarian Nordic countries Centrally planned economy •Production dictated by Plan from above rather than in response to consumer demand •Total price control •In 1980s many countries experienced shortages of almost everything •Top party members and state officials got a privilege access to goods and lower prices. •Loyalty to the regime was a price for privilege. • • Leningrad can be overstocked with cross-country skis and yet go several months without soap for washing dishes. (Hedrick Smith, 1976) The Armenian capital of Yerevan, had an ample supply of accordions but local people complained that they had gone for weeks without ordinary kitchen spoons or tea samovars. (Hedrick Smith, 1976) In Hungary, milk was packed in plastic bags and thus could not be sold the next day and had to be destroyed. Because bread was overproduced in Hungary animals were fed on bread, not only on household plots (Shane 1994) Indeed, the crop failure was so serious that Russia was forced to buy wheat from the United States” (Hammond 1966) A basic rule of thumb was: “If you see something for sale that you want, buy it, because tomorrow there probably won’t be any” (Hammond 1966) Another common saying was, “If you see something for sale that you do not need, buy it anyway. You can trade it with others for what you need.” People had to wait in lines and pay bribes to shopkeepers to obtain products that were common in the marked-based economies of the West. The accepted norm is that the Soviet woman daily spends two hours in line, seven days a week. (Hedrick Smith 1976) Transformation process •Drop in GDP (by 33% and more) •Many local currencies have depreciated •High inflation & unemployment •State ownership replaced by private •Increasing share of informal economy •Political instability (7 countries in war, 8 mil refugees) •Rapidly increasing income inequalities • Inequality rises during the transition What is true about Gini coefficient? 1.The calculation of Gini coefficient does not consider the size of the economy 2.Gini coefficients can be used to measure the poverty across the world 3.The poorer countries have always higher Gini than rich societies 4.Gini stands for General Index of National Inequality •