Frank Cowell HMRCHMT Economics of Taxation 14 December

Frank Cowell: HMRC-HMT Economics of Taxation 14 December 2011 HMRC-HMT Economics of Taxation 2011 http: //darp. lse. ac. uk/HMRC-HMT 9. 2 Income distribution, taxation and redistribution

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

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

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

Frank Cowell: HMRC-HMT Economics of Taxation Quantile Incomes by Households n 1974 2004 Growth 10% $9, 741 $10, 927 12. 2% 20% $16, 285 $18, 500 13. 6% 50% $37, 519 $44, 389 18. 3% 80% $64, 781 $88, 029 35. 9% 90% $83, 532 $120, 924 44. 8% 95% $102, 534 $157, 185 53. 3% De. Navas-Walt et al (2005) Table A-3 More detail. 5

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

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

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

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

Frank Cowell: HMRC-HMT Economics of Taxation Mean incomes by groups of households 1974 2004 Growth 1 st 20% $9, 324 $10, 264 10. 1% 2 nd 20% $23, 176 $26, 241 13. 2% 3 rd 20% $37, 353 $44, 455 19. 0% 4 th 20% $53, 944 $70, 085 29. 9% 5 th 20% $95, 576 $151, 593 58. 6% Overall $43, 875 $60, 528 38. 0% More detail 10

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

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

13 Frank Cowell: HMRC-HMT Economics of Taxation 2: Income shares: US 1967 -2004

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

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

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

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

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

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

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

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

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

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

Frank Cowell: HMRC-HMT Economics of Taxation Income or consumption? Albania Bulgaria Bangladesh Vietnam Nepal Morocco Nicaragua Thailand Peru Panama Russia Brazil Year 1996 1995 2000 1998 1996 1998 2000 1994 1997 1996 See World Bank (2005), page 38 Gini coefficient Consumption Income 0. 252 0. 392 0. 274 0. 392 0. 334 0. 392 0. 362 0. 489 0. 366 0. 513 0. 390 0. 586 0. 417 0. 534 0. 428 0. 523 0. 446 0. 523 0. 468 0. 621 0. 474 0. 478 0. 497 0. 596 24

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

Frank Cowell: HMRC-HMT Economics of Taxation Example 2: International trends (2) n Break down overall inequality to analyse trends: u u u n I = Sj wj Ij + Ibetween can we do this with any inequality measure I? what weights should we use? Traditional approach takes each country as separate unit shows divergence – increase in inequality u but, in effect, weights countries equally u debatable that China gets the same weight as very small countries n New conventional view (Sala-i-Martin 2006) u within-country disparities have increased u not enough to offset reduction in cross-country disparities. u n Components of change in distribution are important u u “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 26

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

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

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

Frank Cowell: HMRC-HMT Economics of Taxation Another application of ranking n Tax and benefit system maps one distribution into another u u n n n Use ranking tools to assess the impact of this in welfare terms Typically this uses one or other concept of Lorenz dominance Linked to effective tax progression u u n c = y T (y ) y: pre-tax income c: post-tax income T is progressive if c Lorenz-dominates y see Jakobsson (1976) , Lambert (2001) 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 30

Frank Cowell: HMRC-HMT Economics of Taxation 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 31

Frank Cowell: HMRC-HMT Economics of Taxation 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 32

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

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

Frank Cowell: HMRC-HMT Economics of Taxation References n n n * Atkinson, A. B. (2004) “Income tax and top incomes over the twentieth century, ” Hacienda Pública Española, 168, 123 -141 De. Navas-Walt, C. , Proctor, B. D. and Lee, C. H. (2005) “Income, poverty, and health insurance coverage in the United States: 2004. ” Current Population Reports P 60 -229, U. S. Census Bureau, U. S. Government Printing Office, Washington, DC. De. Navas-Walt, C. , Proctor, B. D. and Lee, C. H. (2008) “Income, poverty, and health insurance coverage in the United States: 2007. ” Current Population Reports P 60 -235, U. S. Census Bureau, U. S. Government Printing Office, Washington, DC. Jakobsson, U. (1976) “On the measurement of the degree of progression, ” Journal of Public Economics, 5, 161 -168. * Jones, F. (2008) “The effects of taxes and benefits on household income, 2006/07, ” Economic and Labour Market Review, 2, 37 -47. 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 i. Library. Piketty, T. and E. Saez (2003) “Income inequality in the United States, 1913 -1998, ” Quarterly Journal of Economics, 118, 1 -39. Sala-i-Martin, X. (2006) “The world distribution of income: Falling poverty and. . . convergence, period”, Quarterly Journal of Economics, 121 The World Bank (2004) 2005 World Development Report: A Better Investment Climate for Everyone. Oxford University Press, New York The World Bank (2005) 2006 World Development Report: Equity and Development. Oxford University Press, New York 35