Income redistribution – theories and some facts Public Finance' Introductory

Public Finance' Introductory Introduction Income redistribution is the most common activity of government Majority voting Also dictatorships redistribute (Wintrobe, 1998) Welfare economics says little about how to organize it All points on contract curve are equally efficient Their discrimination requires value judgements Economics is (aims to be) a wertfrei science But: if economists ignore distributional consequences of PE redistribution Politicians will not listen to economists → will neglect efficiency aspects of redistribution Useful to underline the costs of different ethical goals Public Finance' Introductory

Public Finance' Introductory Income distribution Income distributions across the advanced democracies reveal large inequalities 2 indicators of inequality used Poverty line: an (arbitrarly defined) level of real income that ensures a minimum standard of living Poverty gap: how much should be transferred to lift everybody above poverty line Literature identifies 2 main causes of income disparities Differences in labour incomes Differences in education 4 problems of measurement Income measured annually → not lifecycle Distribution calculated before taxation → In kind (and some monetary) transfers are omitted Problems defining unit of observation: Individual or family? → Value of time devoted to family (and not remunerated) are also omitted Consumption data may provide better assessment of well-being Public Finance' Introductory

Public Finance' Introductory Fonte: Banca Mondiale Public Finance' Introductory

Evidence of income inequality All countries show a Gini index > 15 Reduction for France, Norway, Italy Increase for USA, China, UK Different economic systems Influence of immigration into the US Large variability for Brasil and Bulgaria Public Finance' Introductory

Lorenz curve (e.g. Italy 2005) Public Finance' Introductory

Justifications for income redistribution Simple utilitarism holds that welfare of society is function of utilities of individual members “Promote Greatest Good for Greatest Number” Welfare of society is max when individuals’ utilities are equal 4 necessary hypotheses U depends only on Y All ind have same U function U’’<0 Total Y is fixed Public Finance' Introductory

Discussion of necessary conditions Not easy to assess that all ind have same U functions → likely to be untrue → we are all different! U’’<0 might also be untrue: it might be constant → if so redistribution does not increase W Friedman and Savage (1962) postulated that MU of Y is U-shaped → if so redistribution should be from middle class towards the poor and the rich! → This is what it is actually happening (Mladenovic, 2000) Y is not fixed → ind can choose whether producing Y or consuming leisure L If taxes increase to implement redistribution, SL decreases, L increases (substitution effect) → Y decreases: less resources to redistribute Public Finance' Introductory

Utilitarian redistribution Utilitarian redistribution Paul gains this much utility Paul’s marginal utility Peter’s marginal utility e This is the net gain to society f Peter loses this much utility d c Take ab from Peter and give to Paul Social welfare maximized MUPeter MUPaul 0’ a b I* Paul’s income Peter’s income

Explanation of diagram 0a: initial income of Paul; 0’a initial income of Peter Subtracting ab to Peter and giving it to Paul raises U of Paul and lowers U of Peter Only W=UPaul+UPeter matters Giving ab to Paul increases UPaul by area efab and lowers UPeter by area abcd Net gain efcd is increase of W Only at Y* increases in W are no longer possible Public Finance' Introductory

Public Finance' Introductory Rawls’ maximin Rawls (A Theory of Justice, 1971) works with a “weakest link” type of SWF Maximin criterion - No inequality acceptable unless it works to the advantage of the least well off Starting from such SWF distribution of Y should eventually be equal, short of redistributing more to those with lower U (maximin) Rawls attributes an ethical value to maximim because, behind a veil of ignorance, everybody is risk averse and prefers a rule that favours him/her in a worst case scenario 2 critiques Maximizing U might be as ethically valuable as maximin Ind might not be behind veil of ignorance and therefore not so risk averse Public Finance' Introductory

Pareto efficient redistribution In all cases examined so far redistribution is not PE If ‘rich’ are altruist [UR=u(YR, YP)] → redistribution is PE → it is voluntary (and voluntarily managed) (Hochman e Rogers, 1969) A PE redistribution is indeed plausible Individual are in fact altruist: they give money to charities notwithstanding the redistribution made by the state Which is the replacement rate between private and public redistribution? Likely to be <1 Social equality makes society function better: also rich ones benefit from that Rich ones afraid to become poor → decide to redistribute so to obtain benefits in the case they’d become poor → like an insurance policy Public Finance' Introductory

Public Finance' Introductory Non egalitarian views Models considered so far impose fundamental principles specifying income distribution that are derived independent of tastes Incomes distributed equally as matter of principle Plato’s 4:1 ratio of highest to lowest income Tobin : equality not wrt Y but wrt certain goods: commodity egalitarism Which ones? Who identifies them? Education? Health care? Housing? → List may be endless if tastes are added Buchanan: only redistributions generated by equitable procedures can be considered equitable Equal opportunities → does not imply equal results Nozick (1975) Maintaining that society must redistribute income is meaningless, because only individuals, not society, possess income A distribution of income is unacceptable only if it is the result of improper rules (e.g. theft) Ethical value of the status quo Another view is that redistribution is not so important provided that social classes are mobile (‘social elevators’) What matters is that individual below poverty line be not always the same Public Finance' Introductory

Expenditure incidence - 1 Measures the impact of expenditure programs on income distribution Difficult to assess because it is difficult to measure Y to begin with Some non monetary incomes are difficult to evaluate (e.g. homeworking, informal sector, durable goods) Which timeframe for Y measurement? Annual or permanent Y? Y of youngsters is comparatively low, of elderly comparatively high Who is the effective Y earner? Ind or family? → Family enjoys scale economies that 2 ind don’t have Relative P must be taken into consideration Expenditure programs affect the relative prices of commodities E.g. Housing subsidies: favor those who purchase a house, but house prices rise Public Finance' Introductory

Expenditure incidence - 2 Other problems PG must be considered Available to everybody but do not go through market How to account for them? Who benefits the most? In-kind transfers must be considered Benefit mostly the poor (targeted ind) Are worth less than their equivalent in cash In-kind transfers force ind to consume a Q of the good that might not be the optimal one Public Finance' Introductory

Pareto inferior in kind transfers Public Finance' Introductory

In kind transfers as efficient as money grants Public Finance' Introductory

The ‘cash vs. in kind’ puzzle Money transfers are always as efficient, and in many cases more efficient, than their equivalent in kind → leave ind free to choose Why are then in kind transfer the rule and money grants the exception? Commodity egalitarism Reduction of fraudulent behavior→ everybody is interested in receiving money (transferable) but not goods (not transferable) Higher administrative costs act as a filter Government wants to favor the producers of goods, not the consumers (nominally targeted ind) Public Finance' Introductory

Public Finance' Introductory The ‘cash-out’ puzzle Cash out puzzle emerges from experiment run by Breunig, Dasgupta, Gundersen, Pattanaik (2001) Food Stamp Program in US Data for families of San Diego County at the end of the 1990s (600 treated, 600 non treated) Food availability considered as PG Puzzling result: in families with more than 1 member the marginal propensity to consume food using food stamps was higher than with money transfer Relationship between composition of family and distribution of resources within the family might be the explanation of the puzzle Public Finance' Introductory