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Accounting for imputed and capital income flows in inequality analyses

Accounting for imputed and capital income flows in inequality analyses Joachim R. Frick* & Markus M. Grabka (DIW Berlin / SOEP, TU Berlin, IZA Bonn)

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Accounting for imputed and capital income flows in inequality analyses

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  1. Accounting for imputed and capital income flows in inequalityanalyses Joachim R. Frick* & Markus M. Grabka (DIW Berlin / SOEP, TU Berlin, IZA Bonn) Pre-APPAM Conference on “European Measures of Income, Poverty, and Social Exclusion: Recent Developments and Lessons for U.S. Poverty Measurement“ Washington / DC, 4 November 2009 * jfrick@diw.de

  2. Income Inequality on the rise (1): Top Decile Income Share in the United States, 1913-2007 Source: Piketty & Saez (2003) Saez (2009: series updated to 2007). Income is defined as market income including capital gains.

  3. Income Inequality on the rise (2) Point Change in Gini (Mid-1980s to Mid-2000s) Source: OECD 2008: Growing Unequal.

  4. Motivation Reasons for rising income inequality in OECD countries • Changes in labor income due to … • Skill-based technological change, SBTC (e.g. Card & DiNardo 2002) • Rising returns to education (e.g. Acemoglu 2002) • Superstar-phenomenon, CEOs (Bebchuk & Grinstein 2005) • Unemployment • Immigration (e.g. Borjas 2006) • Changing demographic structures / population (e.g. Reed 2006) • Share of Immigrants ↑, single HH ↑, lone parents ↑, • Ageing societies (fertility ↓, life expentancy ↑) • Changes in Income portfolios • Research gap: Impact of various income components on inequality  esp. investment income

  5. Motivation Development of income aggregates in the SNA in Germany (1991=100) Source: own calculations based on SVR 2007/08.

  6. Definition Investment income = Capital income + Imputed Rent (NB: Capital gains are not considered) Capital Income (CI) = returns on financial investments Imputed Rent (IR) = returns on investments in real estate

  7. Definition • Investment income = Capital income + Imputed Rent • (NB: Capital gains are not considered) • Capital income (CI): • SNA: „income derived from a resident entity‘s ownership of domestic and foreign assets“ • income on equity (dividends, branch profits,distributed income of corporations, reinvested earnings, etc.) • income on debt (interest) • rent from land (less expenses) • imputed income from net equity in life insurances / pension funds • others (royalties etc.)

  8. Definition • Investment income = Capital income + Imputed Rent (NB: Capital gains are not considered) • Capital income (CI): • SNA: „income derived from a resident entity‘s ownership of domestic and foreign assets“ • income on equity (dividends, branch profits,distributed income of corporations, reinvested earnings, etc.) • income on debt (interest) • rent from land (less expenses) ≠ income from renting & leasing • imputed income from net equity in life insurances / pension funds ≠ not captured in income surveys • others (royalties etc.) ≠ rarely captured in income surveys

  9. Definition • Imputed Rent (IR): • Fictitious income advantage for owner-occupied housing • Investment in real estate rather in the capital market • IR in SNA = production activity  “mixed income” EU-Regulation (to be applied in EU-SILC) • Beneficiaries: owners, tenants with reduced rent, rent-free • Regression-based opportunity cost approach (including Heckman selection correction) • Deduction of all owner-specific costs (net value of IR)

  10. Previous Research Impact of separate components on income inequality: • Capital income: contributionto inequality about 2-3-times higher than its contribution to overall income (e.g. Jäntti 1997 (UK, USA), Becker 2000 (DE), Fräßdorf et al. 2008 (UK, USA, DE)) • Imputed rent: in general, inequality and poverty reducing effect (e.g. Yates 1994 (Australia); Frick & Grabka 2003 (USA, UK, DE); Frick et al. 2007 (various EU countries); AIM-AP project 2006-2009) •  However, no joint consideration of CI and IR. Different from research on the link between “income and imputed flows from net worth” (e.g. Weisbrod & Hansen 1968; Wolff & Zacharias 2009; Smeeding & Thompson 2007)

  11. Data & Methods • Aim • comprehensive and time-consistent analysis of the impact of CI and IRon economic inequality and mobility • Data • German Socio-Economic Panel (SOEP) (longest running European household panel) • representative panel study (2007: about 11,000 households) • oversampling of high income households • survey years 1985-2007 (East Germany 1992-2007) Empirical approach • incidence & relevance of investment income (CI, IR) • inequality decomposition by subgroup and by factor • income mobility

  12. Incidence of CI & IR Population share holding CI / IR (in %) Source: SOEP 1985-2007

  13. Relevance of CI & IR CI & IR as a share of total disposable income (in %) Source: SOEP 1985-2007

  14. Inequality (Gini) • Baseline Income = Post-Gov‘t Income excluding CI and IR • OECD Equivalence Scale (1; 0.5; 0.3) • Comparison of inequality in baseline income to augmented measures

  15. Inequality Gini-coefficient for baseline disposable income Source: SOEP 1985-2007

  16. Inequality Gini-coefficient for baseline disposable income plus Capital Income (CI) Source: SOEP 1985-2007

  17. Inequality Gini-coefficient for baseline disposable income plus Imputed Rent (IR) Source: SOEP 1985-2007

  18. Inequality Gini-coefficient for baseline disposable income plus CI and IR Source: SOEP 1985-2007

  19. Relative Poverty Risk Rate (FGT0) • Poverty line given at 60 % of Median Income • Comparison of poverty in baseline income to augmented measures (re-calculating poverty threshold when adding CI and IR)

  20. Relative Poverty Risk Rate FGT0 for baseline disposable income Source: SOEP 1985-2007

  21. Relative Poverty Risk Rate FGT0 for baseline disposable income plus CI Source: SOEP 1985-2007

  22. Relative Poverty Risk Rate FGT0 for baseline disposable income plus IR Source: SOEP 1985-2007

  23. Relative Poverty Risk Rate FGT0 for baseline disposable income CI and IR Source: SOEP 1985-2007

  24. Who „profits“ most from CI and IR ? • Inequality decomposition by agegroups • Comparison of baseline and „full“ income inequality

  25. Relevance of CI & IR by age CI & IR as a share of full disposable income by age group 24% 17% 14% 13% 12% 10% 9% 9% 8% 9% 6% 7% Source: SOEP

  26. Subgroup decomposition MLD by age groups 2007 – baseline income Inequality is lowest among the elderly Source: SOEP Source: SOEP 2007.

  27. Subgroup decomposition MLD by age groups 2007 – baseline income plus CI and IR • Adding CI & IR ... • Increase in overall inequality +47% • especially within-group inequality is affected • Strongest increase among elderly +107% + 27% + 14% + 36% + 74% + 107% + 47% Source: SOEP Source: SOEP 2007.

  28. What drives the picture: CI or IR ? • Inequality decomposition by income component (Shorrocks 1982)

  29. Factor decomposition Relative contribution of CI & IR to full income Source: SOEP 1985-2007

  30. Factor decomposition Relative contribution of CI & IR to inequality and to full income In recent years (prior to the financial crisis) about 1/3 of inequality is due to CI, less than 5% is due to IR Source: SOEP 1985-2007

  31. Factor decomposition Relative contribution of CI & IR to inequality and to full income When top-coding CI, about 10% of inequality is due to CI Source: SOEP 1985-2007 applying a 1% Top Coding for CI

  32. How do CI and IR impact on income mobility? • Five year windows (1986-1990, ...., 2003-2007) • Shorrocks (1978) mobility measure, using Gini

  33. Income Mobility Shorrocks Mobility over 5 years, using Gini-index Source: SOEP 1986-2007

  34. Income Mobility Shorrocks Mobility over 5 years, using Gini-index Source: SOEP 1986-2007

  35. Income Mobility Shorrocks Mobility over 5 years, using Gini-index Source: SOEP 1986-2007

  36. Income Mobility Shorrocks Mobility over 5 years, using Gini-index Source: SOEP 1986-2007

  37. Summary • Comprehensive and consistent analysis of CI + IR • Inequality and poverty effects • Baseline income: secular trend for increasing inequality • IR dampening effect vs. CI increasing effect • Mobility effects • Baseline income: trend towards decreasing income mobility • IR exerts no relevant effect vs. CI re-inforces overall trend (esp. top incomes) • Inequality decomposition by age • by 2007, CI & IR contribute to almost 25% of full income among those >65 • inequality among the elderly doubles when considering CI & IR • Factor decomposition • in recent years, CI’s inequality share is 7-times higher than its income share • top-coding reveals large measurement issues (volatility) •  If at all possible, differentiate CI and IR in empirical analyses

  38. Conclusion • Relevance for (national) policy recommendations: • Germany is a rapidly ageing society; PAYG-pension system under pressure • Strong age dependency of CI and IR will most likely yield a further increase in economic inequality, esp. among elderly • impact of the financial crisis (yet unclear, need to differentiate short-run financial effects from long-run effects arising from increasing unemployment) • Comparative research needs to consider differences in investment behavior as well as in institutional arrangements (incentive structures) across countries and welfare regimes which impact on the income-wealth nexus: • income  savings  wealth portfolio  determines level, structure and volatility of returns on investment (CI and IR)  income portfolio • this line of thinking may offer one argument for why private households in different countries appear to have been struck differently by the financial crisis: • Germany (still strong public pension system) vs. liberal regimes (US, UK, AUS)

  39. Comments welcome jfrick@diw.de

  40. Relevance of CI & IR CI & IR as a share of total disposable income by income quintile Source: SOEP

  41. Relevance of CI & IR CI & IR as a share of total disposable income by income quintile Source: SOEP

  42. Relevance of CI & IR CI & IR as a share of total disposable income by age group Source: SOEP

  43. Relevance of CI & IR CI & IR as a share of total disposable income by age group Source: SOEP

  44. Incidence of CI & IR Population share holding CI & IR by income quintile 1997 / 2007 Source: SOEP

  45. Incidence of CI & IR Population share holding CI & IR by income quintile 1997 / 2007 Source: SOEP

  46. Incidence of CI & IR Population share holding CI & IR by age groups 1997 / 2007 Source: SOEP

  47. Incidence of CI & IR Population share holding CI & IR by age groups 1997 / 2007 Source: SOEP

  48. Inequality Gini-coefficient for baseline disposable income plus … Source: SOEP 1985-2007

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