Understanding Income Redistribution Policies: Trends, Effects, and Measures

1. Introduction to Income Redistribution Policies Michele Raitano (Sapienza University of Rome) Training Programme “Effects and Tendency of Income Redistribution Policy” Italy, October 14th-28th, 2018

2. Outline • Why focusing on distribution • The concept of wellbeing to be considered and pros and cons of the income concept • The steps of the process of income distribution and the role of pre-distributive and redistributive policies • Trend of income inequality and redistribution in OECD countries • How to measure income redistribution • Main drivers of income inequality trends • Main policies to deal with income inequality: predistribution and redistribution

3. The focus on income distribution • Analyzingdistribution of living standardsiscrucial in terms of bothprocessesdeterminingit (e.g., why are individualsdifferentlypaid?) and itsconsequences on some aggregate outcomes (e.g., growth, health, social cohesion). • Which is the best variable for identifying individual welfare? • Monetary or non monetary indexes? Mono or multidimensional indexes? • Income. • Consumption. • Wealth. • Functionings and capabilities (Sen). • Happiness.

4. Incomeas the proxy of economicwellbeing • Income is the flow of a stock of wealth (physical, financial and human capital). • Monetary and non monetary flows have to be considered. • The “Full income” concept (Simons 1938): consumption plus change in wealth => potential consumption. • Is it possible to exactly compute all income components? • Usually, from “full” to disposable income (only considering personal income taxes and cash welfare benefits). • What does this imply in comparisons across countries and across times?

5. Limits in measuring «full income» Empirically it is very difficult to measure all income components: • Self-employment and business incomes. • Capital gains and changes in asset values. • Unpaid work => market price or opportunity cost approach? • Fringe benefits. • Imputed rents from housing. • In kind welfare transfers: long term care, education, health care (e.g. actual consumption or individual probabilities to be treated?).

6. The steps of personal income distribution (a) From individuals to households (using equivalence scales); from distribution to redistribution. • Individual labour earnings: • Hourly wages, time of work, unemployment spells. • Household (equivalised) market incomes: • Household composition (number of components, ages); • Employment rates (number of income recipients); • Non labour earnings. • Household (equivalised) disposable incomes: • Detracting personal taxes and adding cash transfers. • How to impute in kind benefits, imputed rents, tax expenditures, consumption taxes? Usually not considered => disposable instead than full income • Different mechanisms of inequality in the various steps. • Public policies can act in all steps => redistrib. or predistrib.?

7. The steps of personal income distribution (b) • Different mechanisms of inequality acting (interacting or in contrast each other) in the various steps. • Public policies clearly affect distribution through redistributive measures (tax & transfers, despite the difficulty of considering on income taxes, tax expenditures and in kind transfers). • However, all public policies affect distribution changing markets equilibria in the first two steps (e.g., changing labour market institutions or through employment policies). => Public policies can act in all steps: Redistribution and predistribution

8. Trend of Gini of disposableincome 8

9. Gini of disposableincome in EU in 2015

10. Gini in the EU before and after the crisis

11. The recentstability of disposableincomeineq. in Italy: a puzzle? • Is really inequality rather constant in Italy? • Was the stability in past years a positive outcome? • Are survey data proper to capture recent trends? What happens in the tails? • Are there large internal movements? • What is happening to market incomes? Are market income inequality related to pensioners only? • Is redistribution effectively reducing inequality trends? The role of pensions. • Can increase in top incomes be faced by redistribution only? • Was inequality reduced by the increase in employment rates?

12. Factor decomposition of inequality

13. Gini of market income

14. Gini of market income of householdsheaded by thoseaged 18-65

15. Top 1% income shares

16. Intensity of redistribution

17. Intensity of redistribution (householdsheaded by individualsaged 18-65)

18. Limits in the intensity of redistributionindex • Mix between vertical redistribution and redistribution across individuals life phases. • How much of the difference between Gini of market and disposable income is really due to vertical redistribution? • What is the role of pensions? • Are pensions a mere transfer between individuals instead than between life phases? • Have there been changes across countries and years in the role played by pensions? • How to compute redistribution? Do we take into account both payment and benefit sides?

19. Change in the Gini when cash transfers are notconsidered (a)

20. Change in the Gini when cash transfers are notconsidered (b)

21. Change in the Gini when cash transfers are notconsidered (c)

22. Earnings inequality: P90/P50

23. Gini of annualgross earnings

24. Summarizing the evidence • Generalised rise in inequality, but no common trends => is it possible that inequality strictly depend on «common exogenous natural» factors acting worldwide? • Different indicators and focus on different parts of the income ladder provide some heterogenous findings • Are our data able to precisely capture all features of the recent rise in inequality? The case of top incomes and tax havens…

25. Usual drivers of inequality trends • Changes in skill premia (between inequality) due to technological progress and globalization affecting demand and supply of differently skilled workers. • From SBTC to routinization => polarization (of employment and wages) instead than mere inequality? • Are these trends strengthened by globalization (offshoring and increasing competition from abroad)? Are these trends natural and unavoidable? • Is a single explanation sound due to the multiple country experiences? • Are skill premia responsible of the rise in top incomes?

26. How muchinequalityisexplained by education?

27. Is the trend of inequality in Italyexplained by education?

28. Furtherpossible (maybemain) drivers • What are the determinants of super-earnings? Talent and popularity in “winner takes all markets” or power producing rents? How competitive are the markets? • Is there an oligarch capitalism? • What is the role played by finance? • What is the role played by “structural” reforms? • How has the bargaining power between labour and capital changed? • Has there been an individualization of economic conditions? • Country specific policies towards different levels of market inequality. • Trends in tax & benefit systems.

29. Policies to deal with inequality: an outline • Predistributive strategies • Taxes and redistribution • The welfare state: objectives, characteristics, type of transfers, benefits entitlement and computation rules • Welfare transfers and redistribution • Pros and cons of targeted welfare transfers

30. Predistributive strategies Levelling endowments • Human capital (quantity, quality and its heterogeneity) • Wealth (mostly due to inheritances) Change the rules of the game • Antitrust not only interested at reducing prices • Weakening power related to asymmetric information, property rights, joint consumption => act on firms’ governance Predistributive effects of redistribution • Link between top gross income shares and marginal tax rates. • Incentives to accumulate due to the lack of inheritance taxes • Basic/minimum incomes might change workers’ option value

31. Taxes and effects on redistribution (a) • Taxes have to be assessed according to the tax base: • Persons’ incomes (labour and capital incomes) • Firms’ incomes • Properties • Consumption • Tax expenditures • The effects of taxes on income distribution has to be assessed according to the type of income concept that is affects: i) individuals’ labour incomes; ii) market incomes; iii) disposable incomes; iv) full (extended) incomes

32. Taxes and effects on redistribution (b) • Different taxes affect different income concepts; e.g., consumption taxes act on full income, personal income taxes on individual income. • Progressivity may be assessed within a certain income source or – in general – looking at the effects of disposable/full incomes, thus moving from the individual to the household.

33. Taxes and effects on redistribution (c) • When assessing the effects on distribution 2 effects to be distinguished to assess the progressivity of a tax programme: • Composition effects, between those burdened or not by a certain tax (e.g., taxes on capital incomes between those with or not capital incomes) • Price effects, different relative effects on those who are burdened by a certain tax (e.g., taxes on capital incomes within those holding these incomes).

34. Whatis the welfare state? • How to define it? • Social assistance or social insurance tool? • Public or private instruments? • Public financing and/or public supply? • What components should be included? • How to finance it? Social contribution vs general taxation? • Espros classification by risks sources in EU.

35. Welfare State objectives • Efficiency: macro (total social spending), micro (spending composition), incentives (on individual behaviours). • Living standards protecion: anti-poverty, insurance and income smoothing (life cycle). • Inequality decrease: vertical and horizontal equity => entitlements and computation formulas. • Social cohesion: dignity without stigma and social solidarities (positive freedom as capabilities). • Administrative management: information for citizens, no abuses (no I and II order errors in case of means tested benefits). Normative roles given to the various objectives => different WS models (e.g. universal vs residual) Often trade off between the objectives.

36. Types of welfare state transfers • Their nature: cash or in kind or specific cash transfers (vouchers). • The transfer entitlement: • Social insurance: specific event and seniority record. • Pure universal transfer: only contingency. • Means tested benefit: based on income threshold and, in cases, on events occurrence. • Transfer sectorial: only to employees? The degree of corporativism. • Rights linked to citizenship or to employment (with some duties)? Welfare or workfare? • The benefit computation formula and the distributive effects • Is there a link between the entitlement and the formula? • Are also insurance benefit redistributive? • Crucial factors: risk exposition, entitlement conditions, links between contributions and benefits.

37. Welfare regimes in the EU Beveridgian and Bismarckian models. The literature on welfare regimes: • Esping Andersen (1990) classification (extended by Ferrera 1996). • Usually 4 models: • Social-democratic (Scandinavian); • Liberal (Anglo-saxon); • Corporative (Continental); • Southern. Regimes identified interacting the roles of families, state, markets; the degree of targeting and universalism (i.e., stratification); the corporativisms; the decommodification; the financing method.

38. Welfare state and redistribution (1) • Is redistribution a main WS aim? • Effects through taxes and transfers. • Combination between “piggy bank” and “Robin Hood” => what is the combined impact? • No redistribution by means of insurances? Or differentiated effects due to premium, benefit and the risk probability? • Horizontal (through life phases) and vertical redistribution. • Is there an effect on inequality also in horizontal redistribution? • What is the target efficiency of these benefits? Is there a paradox of redistribution of targeting?

39. Welfare state and redistribution (2) • Biased pre-post comparisons: WS affects pretax distribution: • WS increases market inequalities affecting zero earners (retired, lone mothers, unemployed) and providing lower incentives to work. • Different effects if combined to ALMPs and workfare. • WS as provider of resources changing individual income potential => WS as “social investment state” in education and health. But what is the impact on inequality? • Welfare state also affects net wealth distribution across countries, changing individuals’ incentives to save

40. Welfare and redistribution (3) • Is there a pure counterfactual? • Redistribution assessed on the life-cycle or deleting some groups of individuals? • How to measure the role of in kind transfers? And the role of tax expenditures? • How to assess the interplay of public and private schemes?

41. WS and redistribution • Analyzing how different WS features impact on income distribution => Distribution = f (WS, X, Y) [Where Y is a set of WS complementary political instruments (e.g. labor market institutions), and X are policy exogenous variables] • Both sides of this relationship have to be specified better than it is commonly assumed in the literature: • WS is a very complex institution; every connection between its features have to be deeply evaluated. • The current analyses are based on very rough methodology: simple correlations or econometric models without enough control variables.

42. The left side limits • Which reference population? • Incomes or “economic resources”? • How to measure redistribution?

43. 1. Reference population • Generally core labor force population - aged 25-59 - is used for: • Data availability; • Emphasis on earnings; • More focus on “true” vertical transfers; • Too much emphasis on poverty reduction and transfers effects if the whole population is considered; • But this approach has many drawbacks: • The median voter is getting older; • Comparability among countries with different elderly employment rates; • Pension transfers are not simply actuarial: many different distributive channels, depending on formulas and requirements; • The need to analyze the many distributive effects of pension reforms; • A weak correlations between pension system generosity and pre-transfer poverty.

44. 2. Incomes or economic resources Standard analysis focus only on “market” and “disposable” income; • To evaluate the redistributive WS effects and its tendencies, in-kind benefits and tax expenditures have to be added. • But how to impute in-kind transfers? • Which are the counter-factual of tax expenditures, their link with the private schemes spreading and their distributive channels? • In addition: • Transfers have to be considered net of taxes; • In a resource perspective, disposable income should be corrected also by indirect taxes (sometimes used to finance WS). • Towards a “full (extended) income” concept?

45. 3. How to measure redistribution? • The first studies used public social spending as dependent variable, but it is a very poor proxy of redistribution (it is an input!) • The more recent studies focus on outcomes measures, computing redistribution by a “Pre” and “Post” approach – based on Gini index, but there are some caveats: • Gini index empathizes middle class transfers; • In a counterfactual logic “Pre” is different from “In the Absence of”; WS effects have to be evaluated in every step of the distributive path. • And using Gini, the absolute difference or the percentage change? Is there a level effect? Are there diminishing returns in inequality reduction efforts? • Given different implicit objectives, poverty or distribution indexes?

46. The right side limits • How to “measure” the welfare state [also known as “the dependent variable problem” in political science literature]? • Which are welfare policies limits (e.g. have to be included also education, full-employment?) • Literature is neither able to define if there has been a retrenchment in last 20 years, depending on how WS is measured (spending, entitlements, outcomes)… • Two usual measures: • Social Spending • Entitlements

47. 1. Social spending • Social spending is not a perfect proxy of a welfare state model… Spending = f [entitlements (replacement rates, duration..), recipients (elderly, unemployed…), GDP, production costs for services] • …and different components of social spending may have very different distributive consequences, • …and are included in kind transfers, taxes and tax expenditures?

48. 2. Entitlements • Entitlements indicators seem more fruitful for defining WS models and analyze their differences and the impact of social policies on recipients. • Recent datasets are useful, but here too there are many limits: • Indicators do not seem robust to different specifications; • They are based on few (one or two) illustrative individuals; • They depend strongly on the reference year. • They do not incorporate introduced but still transitional changes in norms. • They are based only on cash transfers!!! What happens to regime theory if services are included? Does education have to be included too? And if yes, which education level? • Tax expenditures and the access to private schemes are not considered.

49. Disentangling targeting • Is targeting really more redistributive and costs saving than universalism? • Is there a redistribution paradox? • What happens when also private schemes are considered? • Targeting and universalism have to be compared in connection with the explicit benefit formula. • Three types of targeting: • Categorical • Means tested • Self targeting

50. Pros and cons of targeting • Pros of targeting • Target efficiency then less poverty and more equality with minor costs • but the paradox of redistribution could appear: the efficiency of each unit of redistribution vs. how many units are available [is the budget sensible to political constituencies]? • The cons of targeting: • Leakages (I & II type errors – especially for categorical) • Administrative costs ( especially for means-tested) • Incentives (poverty traps) • Take up and stigma (especially for self targeting and for means tested information failures) • Towards a citizenship (basic) income?