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Redistributive policies are unable to counter rising income inequality. A reorientation of taxes and transfers is needed from the individual to the household, argues economist Wiemer Salverda.
By Wiemer Salverda
Inequality has risen in most countries over the last three decades. A broad set of countries, ranging from Denmark, Finland, Sweden and the Netherlands to the Baltic states and other countries in Central and Eastern Europe, and including the UK, Australia, Canada and the USA, have seen inequality rise by an average of 28% since the early 1980s. In this article I briefly consider the nature of this rise and subsequently ask the question of whether income redistribution can change this outcome.
A surprisingly large part of the rise in inequality (19%) was concentrated in the 1990s (see Table 1). The measurement is of inequality in net Household income – this is market income with the addition of social transfers and the subtraction of income taxes. Two factors thus combine to cause the increase in inequality: a growing inequality in market incomes and a declining redistribution of income through taxes and transfers. Market incomes have indeed become significantly more unequal, with notorious gains in top incomes in recent years. For a broad range of countries we find an average 21% growth in the top 10% shares since 1980, with more than half of this concentrated in the 1990s. The top 1% incomes trump this growth with a 37% increase and an even stronger concentration in the 1990s.
Though, in principle, the increases in both market income and net income equality would seem sufficient to warrant the conclusion that the redistribution of incomes has diminished, direct research can support this claim. For instance, the Review of Economic Dynamics (2010) shows that the disposable income inequality of households with earnings has trended up. In Canada, research suggests that less than half of the increased market income inequality has been taken away by transfers and taxes since 1980 (Sharpe and Capeluck 2012). In Finland, the effects of redistribution declined during the mid-1990s despite the increasing role of transfers (Blomgren et al. 2012). Other research on net income inequality in Denmark (Bjørnskov et al. 2012) or market income inequality in the uk (Brewer and Wren-Lewis 2012) show similar results. This suggests that even if redistribution is increasing it is usually insufficient to compensate for the growing disparities in market incomes.
Household employment and earnings
Not all households are equally affected by this rising inequality. It has been a long and still unfinished adieu
to the world of the single breadwinner (if it ever existed in a pure form). Currently, dual- and triple-earner households are a majority (57%) of all households receiving an income from paid labour in Europe. Importantly, and unsurprisingly, those households are concentrated in top decile of household earnings. Single-earner households, on the other hand, make up 88% of the bottom decile and only 15% of the top (Salverda and Haas 2014). The share of single-person households has roughly doubled in the same period. This has given rise to a complex situation that institutions and income redistribution policies are still grappling with. It is a change which is permanent in nature (Debacker et al. 2013). Shorter working hours and a lower level of (hourly) pay now correlate more strongly than before: part-time jobs are concentrated at lower levels of pay and occupation, especially in the private sector. At the same time the “new normal” of multiple earning has pulled the additional job growth of the 1990s and 2000s towards households that already had a person in employment, resulting in a limited reduction in Household joblessness at best – if not an increase. Thus the personal
employment to population rate could grow while the household
employment rate lagged or even declined. The uk provides the sharpest example of this separation. In 1980 the two employment rates were roughly equal at 72-74%, but by 2005 the personal employment-to-population rate increased by 5 percentage points while the household employment rate fell by 7 percentage points, opening up a 12 percentage point gap (Blundell and Etheridge 2010, in red 2010).
The new situation has several important implications. First, these developments blunt the use of the traditional unemployment rate as a helpful labour market indicator. Second, as a result of the increased combination of individual (annual) earnings in a household, low-wage workers may now be found in households high up in the income distribution. This blunts individually focused tools for limiting wage inequality, not only traditional tools such as the minimum wage, but also newer ones such as tax credits for employed individuals or exemptions from employer contributions. It makes the case for targeted, household- dependent taxation of individual earnings. For example, households in the top decile in the Netherlands pay an average effective tax rate of slightly less than 20% of gross income but this rate diverges significantly between second earners (12%), first earners (22%), and single earners (27%-28%). The flip side of this is that it may affect solidarity: why should you pay more tax as anindividual with another earner as a partner and a higher household income than another individual who earns the same amount but has a non-earning partner or no partner at all?
What role do policies of redistribution play in this overall inequality picture? These include social transfers (social assistance and socialinsurance), on the one hand, and taxation on the other hand. The weights and effects of the two differ significantly between countries. However, certain changes in recent decades have been widely shared. The levying of income tax has been reduced significantly. In particular, top marginal rates of personal income tax have declined by a quarter, from 56% in 1981 to 41% in 2005. This has lowered current tax receipts and thus the funding of redistribution. Equally important, it has increasingly had a long-run behavioural effect – stimulating high pay in firms and the growth of top incomes (Piketty, Saez and Stantcheva 2011). It may also stimulate savings and the long-run building up of wealth. For Finland the growth of top incomes is attributed to rising capital incomes and the reduced taxation introduced in 1993; despite growth, redistribution has been unable to compensate for the concomitant rise in inequality (Blomgren et al. 2012). However, income tax is only half the story of direct taxation. Many countries levy non-progressive contributions to social security. The overall progressivity differs little between countries, even high-tax ones (oecd 2012). Indirect tax, or the value-added tax (vat), is another important factor – it is regressive, or felt more by those with lower incomes, who consume a larger part of their incomes (if not more than their incomes), and so contribute relatively higher amounts of vat (Figari and Paulus 2012).
In addition to taxation, transfers are the main artery of redistribution aimed at lowering inequality. Its importance varies across countries. In Canada, 70% of lower inequality is ascribed to transfers and only 30% to taxation (Sharpe and Capeluck 2013). In Great Britain the increasing inequality of market incomes (74%) was accompanied by increased mitigation by taxation (+77%), which remained insufficient, while the mitigating effect of transfers trailed far behind (+11%) (Brewer and Wren-Lewis, 2012). In many cases, the reduction of redistribution was the main reason for rising inequality after the mid-1990s (Marx and Van Rie 2014).
Redistributive policies have continued to reduce inequality, but even when their size has grown the effect has diminished in the face of strongly rising inequality in market incomes, particularly household earnings from labour. It puts the need to directly address inequality in market incomes on the agenda, for example by introducing or augmenting minimum wages or by taking away the undue rent seeking (seeking to obtain benefits in the political arena) that seems to have overtaken the highest levels of pay. Though the minimum wage certainly helps improving the living wage of households, its effect on income distribution has become more muted. In addition, the effects of taxes and transfers on the growth of inequality in market incomes have to be scrutinised, such as the long-run behavioural effects of reduced taxation on high incomes, capital incomes, and inheritance. International coordination seems highly advisable in order to put an end to the existing leapfrogging of tax-rate setting which, as it is going in a downhill direction, can only end in a disaster of broken legs and bones. The same holds for the effects of individually based taxation on household outcomes. There is no reason to reorient away from individual towards joint household taxation; instead general tax credits should be checked for their Household effects and replaced by targeted credits where desirable. Beyond the immediate effect on the distribution of earnings and incomes, the longrun focus should be on the household distribution of employment, explicitly including the working-hours dimension. Equally, the long-run view of benefits and social transfers reflects the strong effects of enduring, intergenerational inequality as a result of cuts that are motivated by the short run. By taking these considerations into account, the efficacy and efficiency of the redistributive apparatus may be significantly, and simultaneously, improved.
is Professor Labour Market and Inequality at the University of Amsterdam. The article draws on his contribution to Progressive Economy,
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