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)

Current Population Survey (DeNavas-Walt et al. 2005, 2008)

1. Earnings

2. Unemployment compensation 
3. Workers’ compensation

4. Social security

5. Supplemental security income 
6. Public assistance

7. Veterans’ payments

8. Survivor benefits

9. Disability benefits
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
3
Frank Cowell: HMRC-HMT Economics of Taxation
What is income? (2)

Covers money income received


Before deductions




personal income taxes
social security, union dues
Medicare deductions
Does not include noncash benefits







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

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%
DeNavas-Walt et al (2005) Table A-3
More detail.
5
Frank Cowell: HMRC-HMT Economics of Taxation
Quantiles: 1967 – 2004
$180,000
q.10
q.20
q.50
q.80
q.90
q.95
$160,000
$140,000
$120,000
$100,000
$80,000
$60,000
$40,000
$20,000
$0
1965
1970
1975
1980
1985
1990
1995
2000
2005
6
$180,000
$160,000
$140,000
$120,000
1974
income
Frank Cowell: HMRC-HMT Economics of Taxation
The Parade: quantiles vs population
2004
$100,000
$80,000
$60,000
$40,000
$20,000
$0
0
0.2
0.4
0.6
proportion of population
0.8
1
7
Frank Cowell: HMRC-HMT Economics of Taxation
Quantile ratios: US 1967 – 2004
4.00
q.95/q.50
q.90/q.50
q.80/q.50
q.20/q.50
q.10/q.50
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0.00
1965
1970
1975
1980
1985
1990
1995
2000
2005
8
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
1st 20%
$9,324
$10,264
10.1%
2nd 20%
$23,176
$26,241
13.2%
3rd 20%
$37,353
$44,455
19.0%
4th 20%
$53,944
$70,085
29.9%
5th 20%
$95,576
$151,593
58.6%
Overall
$43,875
$60,528
38.0%
More detail
10
Frank Cowell: HMRC-HMT Economics of Taxation
Differential growth of mean
incomes
Me an Income s US
$160,000
$140,000
Lowest 20%
Second 20%
Third 20%
Fourth 20%
Highest 20%
$120,000
$100,000
$80,000
$60,000
$40,000
$20,000
$0
1965
1970
1975
1980
1985
1990
1995
2000
2005
11
$70,000
$60,000
$50,000
1974
$40,000
2004
income
Frank Cowell: HMRC-HMT Economics of Taxation
1: The Generalised Lorenz Curve
$30,000
$20,000
$10,000
$0
0
0.2
0.4
0.6
0.8
proportion of population
1
12
Frank Cowell: HMRC-HMT Economics of Taxation
2: Income shares: US 1967-2004
60
50
s1
s2
40
s3
s4
30
s5
20
10
0
1965
1970
1975
1980
1985
1990
1995
2000
2005
13
50
45
P90–100
40
35
30
P99–100
CG excl
25
20
15
P99–100
CG Incl
10
5
Source: Piketty and Saez (2003)
1997
1993
1989
1985
1981
1977
1973
1969
1965
1961
1957
1953
1949
1945
1941
1937
1933
1929
1925
1921
1917
0
1913
Frank Cowell: HMRC-HMT Economics of Taxation
2: Top income shares in US
14
Frank Cowell: HMRC-HMT Economics of Taxation
Top income shares in the UK
Source: Atkinson, (2004)
15

1
1974

0.8
2004
0.6
Equality
proportion of income
Frank Cowell: HMRC-HMT Economics of Taxation
3: Lorenz curve
Natural
interpretation in
terms of shares
Gives a natural
definition of the Gini
coefficient
0.4
0.2
0
0
0.2
0.4
0.6
0.8
1
proportion of population
16
Frank Cowell: HMRC-HMT Economics of Taxation
UK “Original income” – GLC
£35,000
£30,000
£25,000
£20,000
1992
1998/99
2005/6
£15,000
£10,000
£5,000
£0
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
Proportion of population
Note: in December 2005 prices
17
Frank Cowell: HMRC-HMT Economics of Taxation
UK “Final income” – GLC
£35,000
£30,000
£25,000
£20,000
1992
1998/99
2005/6
£15,000
£10,000
£5,000
£0
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
Proportion of population
Note: in December 2005 prices
18
1.0
0.9
Equality
1992
1998/99
2006/7
0.8
0.7
Proportion of Income
Frank Cowell: HMRC-HMT Economics of Taxation
UK “Original income” – Lorenz
0.6
0.5
0.4
0.3
0.2
0.1
0.0
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
Proportion of population
0.8
0.9
1.0
19
1.0
0.9
Equality
1992
1998/99
2006/7
0.8
0.7
Proportion of Income
Frank Cowell: HMRC-HMT Economics of Taxation
UK “Final income” – Lorenz
0.6
0.5
0.4
0.3
0.2
0.1
0.0
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
Proportion of population
0.8
0.9
1.0
20
0.6
0.5
0.4
0.3
0.2
0.1
Gini
GE0
GE1
A.25
A.50
A.75
0
19
67
19
70
19
73
19
76
19
79
19
82
19
85
19
88
19
91
19
94
19
97
20
00
20
03
Frank Cowell: HMRC-HMT Economics of Taxation
Example 1: Inequality measures and
US experience

Source: DeNavas-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
1.0
Sweden 2000 inc 25
India 1999–00 exp 32.5
0.9
United States 2000 inc 40.8
0.8
United Kingdom 1999 inc 36
China 2001 exp 44.7
0.7
Russia 2000 exp 45.6
Brazil 1998 inc 59.1
0.6
0.5
0.4
0.3
Proportion of Income
Frank Cowell: HMRC-HMT Economics of Taxation
Lorenz around the world…
0.2
0.1
0.0
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
Proportion of population
0.8
0.9
1.0
23
Source World Bank (2004)
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
1998
2000
1994
1997
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

Source: OECD (2011)
25
Frank Cowell: HMRC-HMT Economics of Taxation
Example 2: International trends (2)

Break down overall inequality to analyse trends:




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
 but, in effect, weights countries equally
 debatable that China gets the same weight as very small countries
 New conventional view (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




“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
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0

Source: Sala-i-Martin (2006)
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
Gini
GE0
GE1
A.50
A1.0
1970
Frank Cowell: HMRC-HMT Economics of Taxation
Inequality measures and World
experience
27
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
GE0
GE0 betw
GE0 within
GE1
GE1 betw
GE1 within
19
70
19
73
19
76
19
79
19
82
19
85
19
88
19
91
19
94
19
97
20
00
Frank Cowell: HMRC-HMT Economics of Taxation
Inequality measures and World
experience: breakdown

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

Tax and benefit system maps one
distribution into another





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



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
1.0
 + cash benefits
(Equality Line)
Original Income
Gross Income
Disposable Income
After Tax Income
Final Income
0.9
  direct taxes
0.8
  indirect taxes
0.7
 + noncash benefits
Proportion of Income
Frank Cowell: HMRC-HMT Economics of Taxation
0.0
Impact of Taxes and Benefits.
UK 2006/7. Lorenz Curve
0.6
0.5
0.4
0.3
0.2
Big effect from benefits side
Modest impact of taxes
Direct and indirect taxes work
in opposite directions
0.1
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
Proportion of population
0.8
0.9
1.0
31
Frank Cowell: HMRC-HMT Economics of Taxation
0.0
Impact of Taxes and Benefits.
UK 2006/7. GLC
£40,000
 + cash benefits
Original Income
Gross income
Disposable income
Post-tax income
Final income
£35,000
£30,000
  direct taxes
  indirect taxes
 + noncash benefits
£25,000
£20,000
£15,000
£10,000
Final income does not secondorder dominate original income
£5,000
£0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
Proportion of population
0.8
0.9
1.0
32
0.4
direct 1992
1998/9
2006/7
indirect 1992
1998/9
2006/7
0.3
0.2
0.1
10
th
h
p
9t
h
8t
h
7t
h
6t
h
5t
h
4t
3r
d
2n
d
To
to
m
10
t
h
0
Bo
t
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

2nd-order (GL)-dominance: ranking by cumulations


Lorenz dominance equivalent to ranking by shares




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
 Makes inequality measures especially interesting
Use I-measures to capture effective tax progression
34
Frank Cowell: HMRC-HMT Economics of Taxation
References











* Atkinson, A. B. (2004) “Income tax and top incomes over the twentieth century,”
Hacienda Pública Española, 168, 123-141
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. (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.
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 iLibrary.
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