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ECON 361: Income Distributions and Problems ofInequality

David Rose

Queen’s University

February 7, 2018

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Last class...

I Top income share in Canada- Veall (2012)

I Income inequality in the U.S. - Piketty & Saez (2003)

Today ...

I The Top 1 Percent in an International and Historical Perspective

I Income Inequality and Progressive Taxation in China and India

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Remember that time we talked about technology...

Across developed counties we see two distinct patterns in the topincome shares:

1. The “U-shape”: Anglo-Saxon countries

2. The “L-shape”: France, Germany, Japan, etc.

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Sps. skills biased technological change (SBTC) is the main event:

Canucks and Aussies adopt cutting edge U.S. technology but thecontinental Europeans and Japanese don’t?

I Hard to understand why countries on the tech. frontier would seedifferent trends if this was the driving force

Why are these Anglo-Saxon countries so “special”?

I Institutions? Culture?

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Alvaredo et al. think something else is going on ...

Traditional story:

I Rising income inequality in the U.S. due to increasing skillpremium

1. globalization2. skill-biased technological change

Some Stranger Things going on:

I Lots of the action at very topI S & D for skills probably aren’t a good explanation for this

I Need to look beyond earned incomes

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“You have to pay them in Iraq, you can pay them as a VAT”

- not Dr. Seuss

Taxation probably has a role in the 1% share:

I U.S., France, U.K, Germany all saw declines in top marginal taxrates after 1970

I The U.S. super-sized its cuts

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Exhibit A:

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Exhibit A: the remix

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Observations:

I Strong negative correlation between change in the top 1% share ofincome and the change in the top marginal tax rate

I Recall: correlation 6= causation ... this is just descriptive

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Story time: Top Marginal Tax Rates and the 1 PercentShare

1. Slemrod (1996): fall in tax rate decreased the incentives for topearners to engage in “tax avoidance”I Cost benefit calculation for hiding income, now the benefit is lower

I Alvaredo et al. are not swayed:

I This can’t explain a long-run surge

I Same story when we include capital-gains (much easier to hide thisincome)

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2. Lindsey (1987) and Feldstein (1995): lower taxes created moreincentive for talented people to work harder, greaterentrepreneurship, etc.

Taking this seriously:

I The standard optimal tax formula implies, with an elasticity oftaxable income of 0.5, that the revenue-maximizing top taxrate would be 57 percent (Diamond and Saez 2011).

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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)I This produces some amount of surplus that they bargain over

I Often Nash Bargaining is used in these models (not our focus here)

I Key: β represents the worker’s share of surplus and (1− β) is thefirm’ share

I β high =⇒ the worker has high bargaining power

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Intuition for the Bargaining Story:

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Why bargaining models of wage determination matter:

When top marginal tax rates fell, high earners started bargaining moreaggressively to increase their compensation.

It does not follow that the 1%’s higher share is followed by increasedoutput ... it doesn’t reflect higher economic growth.

Taking this seriously:

I 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 correlationbetween cuts in top tax rates and growth rates in real per capita GDP

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4. What if there’s no causal link between the observation that the top1% share increased while top tax rates were being cut? Maybe it’smerely a coincidence.

Keep in mind that we are trying to rationalize a correlation.

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Another Candidate Explanation:

Intergenerational wealth accumulation is getting easier.

Piketty (2011): A number of countries are witnessing a return ofinheritance as a major factor

I slower economic growth

I lower rates of taxation of capital

I lower rates of taxation on inheritance and gifts

Need to consider bequests (at time of death) and inter vivos gifts.

I Very hard to collect data on this

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Takeaways:

I Top income shares evolved differently between English speakingand non-English speaking developed countries

I Unlikely that technological progress can account for all of the risein English-speaking countries

I Changes in top marginal tax rates may help explain some of theincrease in the top 1% share

I It’s hard to pin-down the mechanism

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Piketty and Qian (2009)

Motivation:

I Lots of policy reform for LDCs is about improving effectiveness ofservices, making institutions market friendly, liberalizing trade, etc.

I Little attention is paid to the need for modern income tax systems

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Why we should think about tax systems:

1. LDCs often rely of very distortionary tax tools - e.g. taxes on tradeor specific consumption goods

2. Can potentially raise the tax revenues needed to provide publicgoods

3. Progressive taxation is one of the least distortionary tools forcontrolling the rise from inequality

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Real per capita GDP increased by almost 200 percent in China between1986 and 2003 and by slightly less than 80 percent in India

I 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)

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China’s Income Tax System

Pre-reform: all Chinese workers worked for the state and paid animplicit tax (from their wages).

Expansion of the private sector by the market reforms decreased thegovernments ability to tax in this manner

I Individual taxation introduced officially in 1980

I Gov’t very clever: to avoid upsetting people they set the deductibleamount very high!I Almost nobody paid tax in 1980

I Fairly steady individual tax system since then

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India’s Income Tax System

A different story:

I Introduced by the British in 1922

I Underwent a lot of changes (almost constant changes) during the1988-2008 period

I The exemption has almost kept pace with nominal income growthI tweaking of tax rates for different bracketsI increases in the personal exemption amount

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The differing taxation policies have resulted in large differences in thedevelopment of their tax bases:

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Let me help you plan your weekend:

Midterm: Things we’ve covered

Tools:

1. Poverty Measures: Notes & Ch 3 and 4 of the World BankHandbook on Poverty and Inequality, Low Income Lines, 2011-2012.

2. Inequality Measures: Notes & Ch 6 of the WB Handbook onPov & Ineq.

3. Taxes and Transfers: Notes & Ch 15 of the WB Handbook onPov & Ineq.

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Main papers we have covered:

1. Osberg, Lars and Kuan Xu (1999). Poverty Intensity: How Well DoCanadian 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 LessSuccessful in the Fight Against Poverty.

4. Fortin, Nicole, Green, David A., Lemieux, Thomas, Milligan, Kevinand W. Craig Riddell (2012). Canadian Inequality: RecentDevelopments and Policy Options.

5. Chawla, Raj K. (2004). Wealth Inequality by Province.

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6. Ravallion, Martin (2014). Income Inequality in the DevelopingWorld.

7. Veall, Michael R. (2012). Top Income Shares in Canada; RecentTrends and Policy Implications.

8. Piketty, Thomas and Emmanuel Saez (2003). Income Inequality inthe United States.

9. Alvaredo, Facundo, Atkinson, Anthony B., Piketty, Thomas, andEmmanuel Saez (2013). The Top 1 Percent in International andHistorical Perspective

10. Piketty, Thomas and Nancy Qian (2009). Income Inequality andProgressive Income Taxation in China and India, 1986-2015