Frank Cowell: HMRC-HMT Economics of Taxation HMRC-HMT Economics of Taxation Income distribution, taxation and redistribution 14 December 2011

Frank Cowell: HMRC-HMT Economics of Taxation 2 Overview... Income distribution Inequality trends Inequality internationally Redistribution Income distribution, taxation, redistribution Use US data as a working template

Frank Cowell: HMRC-HMT Economics of Taxation 3 What is income? (1) 1. Earnings 1. Earnings 2. Unemployment compensation 2. Unemployment compensation 3. Workers’ compensation 3. Workers’ compensation 4. Social security 4. Social security 5. Supplemental security income 5. Supplemental security income 6. Public assistance 6. Public assistance 7. Veterans’ payments 7. Veterans’ payments 8. Survivor benefits 8. Survivor benefits 9. Disability benefits 9. Disability benefits 10. Pension or retirement income 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 Current Population Survey (DeNavas-Walt et al., ) Current Population Survey (DeNavas-Walt et al. 2005, 2008)

Frank Cowell: HMRC-HMT Economics of Taxation 4 What is income? (2) Covers money income received Covers money income received  exclusive of certain money receipts such as capital gains Before deductions Before deductions  personal income taxes  social security, union dues  Medicare deductions Does not include noncash benefits 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… Examine CPS distributional data…

Frank Cowell: HMRC-HMT Economics of Taxation 5 Quantile Incomes by Households %$9,741 20%$16,285 50%$37,519 80%$64,781 90%$83,532 95%$102, $10,927 $18,500 $44,389 $88,029 $120,924 $157,185 Growth 12.2% 13.6% 18.3% 35.9% 44.8% 53.3% More detail. Table A-3 DeNavas-Walt et al (2005) Table A-3 DeNavas-Walt et al (2005)

Frank Cowell: HMRC-HMT Economics of Taxation 6 Quantiles: 1967 – 2004

Frank Cowell: HMRC-HMT Economics of Taxation 7 The Parade: quantiles vs population

Frank Cowell: HMRC-HMT Economics of Taxation 8 Quantile ratios: US 1967 – 2004

Frank Cowell: HMRC-HMT Economics of Taxation 9 Overview... Income distribution Inequality trends Inequality internationally Redistribution Income distribution, taxation, redistribution Developments in the USA and UK

Frank Cowell: HMRC-HMT Economics of Taxation st 20%$9,324 2 nd 20%$23,176 3 rd 20%$37,353 4 th 20%$53,944 5 th 20%$95,576 Overall$43, $10,264 $26,241 $44,455 $70,085 $151,593 $60,528 Growth 10.1% 13.2% 19.0% 29.9% 58.6% 38.0% Mean incomes by groups of households More detail

Frank Cowell: HMRC-HMT Economics of Taxation 11 Differential growth of mean incomes

Frank Cowell: HMRC-HMT Economics of Taxation 12 1: The Generalised Lorenz Curve

Frank Cowell: HMRC-HMT Economics of Taxation 13 2: Income shares: US

Frank Cowell: HMRC-HMT Economics of Taxation 14 2: Top income shares in US Source: Piketty and Saez (2003)Piketty and Saez (2003)

Frank Cowell: HMRC-HMT Economics of Taxation 15 Top income shares in the UK Atkinson, (2004) Atkinson, (2004) Source: Atkinson, (2004)Atkinson, (2004)

Frank Cowell: HMRC-HMT Economics of Taxation 16 3: Lorenz curve Natural interpretation in terms of shares Natural interpretation in terms of shares Gives a natural definition of the Gini coefficient Gives a natural definition of the Gini coefficient

Frank Cowell: HMRC-HMT Economics of Taxation 17 UK “Original income” – GLC Note: in December 2005 prices

Frank Cowell: HMRC-HMT Economics of Taxation 18 UK “Final income” – GLC Note: in December 2005 prices

Frank Cowell: HMRC-HMT Economics of Taxation 19 UK “Original income” – Lorenz

Frank Cowell: HMRC-HMT Economics of Taxation 20 UK “Final income” – Lorenz

Frank Cowell: HMRC-HMT Economics of Taxation 21 Example 1: Inequality measures and US experience Source: Source: DeNavas-Walt et al. (2005)DeNavas-Walt et al. (2005)

Frank Cowell: HMRC-HMT Economics of Taxation 22 Overview... Income distribution Inequality trends Inequality internationally Redistribution Income distribution, taxation, redistribution Comparisons across countries? Convergence?

Frank Cowell: HMRC-HMT Economics of Taxation 23 Lorenz around the world… Source World Bank (2004) World Bank (2004)World Bank (2004)

Frank Cowell: HMRC-HMT Economics of Taxation 24 Income or consumption? Gini coefficient YearConsumptionIncome Albania Bulgaria Bangladesh Vietnam Nepal Morocco Nicaragua Thailand Peru Panama Russia Brazil See World Bank (2005), page 38 World Bank (2005)World Bank (2005)

Frank Cowell: HMRC-HMT Economics of Taxation Example 2: International trends 25 Source: OECD (2011) Source: OECD (2011)OECD (2011)OECD (2011)

Frank Cowell: HMRC-HMT Economics of Taxation 26 Example 2: International trends (2) Break down overall inequality to analyse trends: Break down overall inequality to analyse trends:  I =  j w j I j + I betwee n  can we do this with any inequality measure I?  what weights should we use? Traditional approach takes each country as separate unit 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) New conventional view (Sala-i-Martin 2006) (Sala-i-Martin 2006) (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 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

Frank Cowell: HMRC-HMT Economics of Taxation 27 Inequality measures and World experience Source: Sala-i-Martin (2006) Source: Sala-i-Martin (2006)Sala-i-Martin (2006Sala-i-Martin (2006

Frank Cowell: HMRC-HMT Economics of Taxation 28 Inequality measures and World experience: breakdown Source: Sala-i-Martin (2006) Source: Sala-i-Martin (2006)Sala-i-Martin (2006Sala-i-Martin (2006

Frank Cowell: HMRC-HMT Economics of Taxation 29 Overview... Income distribution Inequality trends Inequality internationally Redistribution Income distribution, taxation, redistribution Impact of taxes and benefits

Frank Cowell: HMRC-HMT Economics of Taxation 30 Another application of ranking Tax and benefit system maps one distribution into another 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 Use ranking tools to assess the impact of this in welfare terms Typically this uses one or other concept of Lorenz dominance Typically this uses one or other concept of Lorenz dominance Linked to effective tax progression Linked to effective tax progression  T is progressive if c Lorenz-dominates y  see Jakobsson (1976), Lambert (2001) Jakobsson (1976)Jakobsson (1976) What distributional ranking would we expect to apply to these 5 concepts? 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

Frank Cowell: HMRC-HMT Economics of Taxation 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

Frank Cowell: HMRC-HMT Economics of Taxation 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

Frank Cowell: HMRC-HMT Economics of Taxation 33 Implied tax rates in Economic and Labour Market Review  Formerly Economic Trends. Taxes as proportion of gross income – see Jones, (2008) Jones, (2008)Jones, (2008)

Frank Cowell: HMRC-HMT Economics of Taxation 34 Summary 2nd-order (GL)-dominance: ranking by cumulations 2nd-order (GL)-dominance: ranking by cumulations  From lecture 1 Lorenz dominance equivalent to ranking by shares 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 If Lorenz-curves intersect unambiguous inequality orderings not possible  Makes inequality measures especially interesting Use I-measures to capture effective tax progression Use I-measures to capture effective tax progression

Frank Cowell: HMRC-HMT Economics of Taxation 35 References * Atkinson, A. B. (2004) “Income tax and top incomes over the twentieth century,” Hacienda Pública Española, 168, * Atkinson, A. B. (2004) “Income tax and top incomes over the twentieth century,” Hacienda Pública Española, 168, * Atkinson, A. B. (2004) * Atkinson, A. B. (2004) 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. (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. (2005) DeNavas-Walt, C., Proctor, B. D. and Lee, C. H. (2005) 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. 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. DeNavas-Walt, C., Proctor, B. D. and Lee, C. H. (2008) DeNavas-Walt, C., Proctor, B. D. and Lee, C. H. (2008) Jakobsson, U. (1976) “On the measurement of the degree of progression,” Journal of Public Economics, 5, Jakobsson, U. (1976) “On the measurement of the degree of progression,” Journal of Public Economics, 5, Jakobsson, U. (1976) Jakobsson, U. (1976) * Jones, F. (2008) “The effects of taxes and benefits on household income, 2006/07,” Economic and Labour Market Review, 2, * Jones, F. (2008) “The effects of taxes and benefits on household income, 2006/07,” Economic and Labour Market Review, 2, * Jones, F. (2008) * Jones, F. (2008) Lambert, P. J. (2001) The Distribution and Redistribution of Income (Third ed.). Manchester: Manchester University Press. 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. OECD (2011) Divided We Stand: Why Inequality Keeps Rising OECD iLibrary. OECD (2011) OECD (2011) Piketty, T. and E. Saez (2003) “Income inequality in the United States, ,” Quarterly Journal of Economics, 118, Piketty, T. and E. Saez (2003) “Income inequality in the United States, ,” Quarterly Journal of Economics, 118, Piketty, T. and E. Saez (2003) Piketty, T. and E. Saez (2003) Sala-i-Martin, X. (2006) “The world distribution of income: Falling poverty and... convergence, period”, Quarterly Journal of Economics, 121 Sala-i-Martin, X. (2006) “The world distribution of income: Falling poverty and... convergence, period”, Quarterly Journal of Economics, 121 Sala-i-Martin, X. (2006) Sala-i-Martin, X. (2006) The World Bank (2004) 2005 World Development Report: A Better Investment Climate for Everyone. Oxford University Press, New York The World Bank (2004) 2005 World Development Report: A Better Investment Climate for Everyone. Oxford University Press, New York The World Bank (2004) The World Bank (2004) The World Bank (2005) 2006 World Development Report: Equity and Development. Oxford University Press, New York The World Bank (2005) 2006 World Development Report: Equity and Development. Oxford University Press, New York The World Bank (2005) The World Bank (2005)