ECON 361: Income Distributions and Problems of Inequality
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1 ECON 361: Income Distributions and Problems of Inequality David Rosé Queen s University February 9, /35
2 Last class... Top income share in Canada- Veall (2012( Income inequality in the U.S. - Piketty & Saez (2003) Today... The Top 1 Percent in an International and Historical Perspective Income Inequality and Progressive Taxation in China and India 2/35
3 3/35
4 Remember that time we talked about technology... Across developed counties we see two distinct patterns in the top income shares: 1. The U-shape : Anglo-Saxon countries 2. The L-shape : France, Germany, Japan, etc. 4/35
5 5/35
6 6/35
7 Sps. skills biased technological change (SBTC) is the main event: Canucks and Aussies adopt cutting edge U.S. technology but the continental Europeans and Japanese don t? Hard to understand why countries on the tech. frontier would see different trends if this was the driving force Why are these Anglo-Saxon countries so special? Institutions? Culture? 7/35
8 Alvaredo et al. think something else is going on... Traditional story: Rising income inequality in the U.S. due to increasing skill premium 1. globalization 2. skill-biased technological change Some Stranger Things going on: Lots of the action at very top S & D for skills probably aren t a good explanation for this Need to look beyond earned incomes 8/35
9 Inspiring Tax Related Quote Here - not Dr. Seuss Taxation probably has a role in the 1% share: U.S., France, U.K, Germany all saw declines in top marginal tax rates after 1970 The U.S. super-sized its cuts 9/35
10 Exhibit A: 10/35
11 11/35
12 Observations: Strong negative correlation between change in the top 1% share of income and the change in the top marginal tax rate Recall: correlation causation... this is just descriptive 12/35
13 Story time: Top Marginal Tax Rates and the 1 Percent Share 1. Slemrod (1996): fall in tax rate decreased the incentives for top earners to engage in tax avoidance Cost benefit calculation for hiding income, now the benefit is lower Alvaredo et al. are not swayed: This can t explain a long-run surge Same story when we include capital-gains (much easier to hide this income) 13/35
14 2. Lindsey (1987) and Feldstein (1995): lower taxes created more incentive for talented people to work harder, greater entrepreneurship, etc. Taking this seriously: The standard optimal tax formula implies, with an elasticity of taxable income of 0.5, that the revenue-maximizing top tax rate would be 57 percent (Diamond and Saez 2011). 14/35
15 What if we don t (take the plain-vanilla labour market model seriously)? Search and Matching Literature 3. Workers and firms find each other and decide to have a relationship (i.e. match) This produces some amount of surplus that they bargain over Often Nash Bargaining is used in these models (not our focus here) Key: β represents the worker s share of surplus and (1 β) is the firm share β high = the worker has high bargaining power 15/35
16 Intuition for the Bargaining Story: 16/35
17 Why bargaining models of wage determination matter: When top marginal tax rates fell, high earners started bargaining more aggressively to increase their compensation. It does not follow that the 1% s higher share is followed by increased output... it doesn t reflect higher economic growth. Taking this seriously: Top tax rate could potentially be set as high as 83 percent (Piketty, Saez,and Stantcheva 2011). Piketty, Saez, and Stantcheva (2011) find no apparent correlation between cuts in top tax rates and growth rates in real per capita GDP 17/35
18 4. What if there s no causal link between the observation that the top 1% share increased while top tax rates were being cut? Maybe it s merely a coincidence. Keep in mind that we are trying to rationalize a correlation. 18/35
19 Another Candidate Explanation: Intergenerational wealth accumulation is getting easier. Piketty (2011): A number of countries are witnessing a return of inheritance as a major factor slower economic growth lower rates of taxation of capital lower rates of taxation on inheritance and gifts Need to consider bequests (at time of death) and inter vivos gifts. Very hard to collect data on this 19/35
20 20/35
21 Takeaways: Top income shares evolved differently between English speaking and non-english speaking developed countries Unlikely that technological progress can account for all of the rise in English-speaking countries Changes in top marginal tax rates may help explain some of the increase in the top 1% share It s hard to pin-down the mechanism 21/35
22 Piketty and Qian (2009) Motivation: Lots of policy reform for LDCs is about improving effectiveness of services, making institutions market friendly, liberalizing trade, etc. Little attention is paid to the need for modern income tax systems 22/35
23 Why we should think about tax systems: 1. LDCs often rely of very distortionary tax tools - e.g. taxes on trade or specific consumption goods 2. Can potentially raise the tax revenues needed to provide public goods 3. Progressive taxation is one of the least distortionary tools for controlling the rise from inequality 23/35
24 24/35
25 Real per capita GDP increased by almost 200 percent in China between 1986 and 2003 and by slightly less than 80 percent in India 6.4 percent per year in China and 3.3 percent per year in India The top 1% s income grew even faster! (hence the growing share) 25/35
26 China s Income Tax System Pre-reform: all Chinese workers worked for the state and paid an implicit tax (from their wages). Expansion of the private sector by the market reforms decreased the governments ability to tax in this manner Individual taxation introduced officially in 1980 Gov t very clever: to avoid upsetting people they set the deductible amount very high! Almost nobody paid tax in 1980 Fairly steady individual tax system since then 26/35
27 27/35
28 India s Income Tax System A different story: Introduced by the British in 1922 Underwent a lot of changes (almost constant changes) during the period The exemption has almost kept pace with nominal income growth tweaking of tax rates for different brackets increases in the personal exemption amount 28/35
29 29/35
30 The differing taxation policies have resulted in large differences in the development of their tax bases: 30/35
31 31/35
32 32/35
33 Let me help you plan your weekend: Midterm: Things we ve covered Tools: 1. Poverty Measures: Notes & Ch 3 and 4 of the World Bank Handbook on Poverty and Inequality, Low Income Lines, Inequality Measures: Notes & Ch 6 of the WB Handbook on Pov & Ineq. 3. Taxes and Transfers: Notes & Ch 15 of the WB Handbook on Pov & Ineq. 33/35
34 Main papers we have covered: 1. Osberg, Lars and Kuan Xu (1999). Poverty Intensity: How Well Do Canadian Provinces Compare? 2. Osberg, Lars (2000). Poverty in Canada and the United States: Measurement, Trends, and Implications. 3. The Developing World is Poorer Than We Thought, but No Less Successful in the Fight Against Poverty. 4. Fortin, Nicole, Green, David A., Lemieux, Thomas, Milligan, Kevin and W. Craig Riddell (2012). Canadian Inequality: Recent Developments and Policy Options. 5. Chawla, Raj K. (2004). Wealth Inequality by Province. 34/35
35 6. Ravallion, Martin (2014). Income Inequality in the Developing World. 7. Veall, Michael R. (2012). Top Income Shares in Canada; Recent Trends and Policy Implications. 8. Piketty, Thomas and Emmanuel Saez (2003). Income Inequality in the United States. 9. Alvaredo, Facundo, Atkinson, Anthony B., Piketty, Thomas, and Emmanuel Saez (2013). The Top 1 Percent in International and Historical Perspective 10. Piketty, Thomas and Nancy Qian (2009). Income Inequality and Progressive Income Taxation in China and India, /35
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