1. Income redistribution – theories and some facts
Public Finance' Introductory

2. 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

3. 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

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

5. 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
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6. Lorenz curve (e.g. Italy 2005)
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7. 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

8. 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

9. 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

10. 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
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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

12. 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
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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

14. 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

15. 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
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16. Pareto inferior in kind transfers
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17. In kind transfers as efficient as money grants
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18. 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)
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19. 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