Tag Archives: Lorenz Curve

Inequality after tax and transfer payments

The Economist had a very informative graphic which looked at the change in the Gini coefficient after taxes and transfers. The Gini Coefficient is derived from the same information used to create a Lorenz Curve. The co-efficient indicates the gap between two percentages: the percentage of population, and the percentage of income received by each percentage of the population. In order to calculate this you divide the area between the Lorenz Curve and the 45° line by the total area below the 45° line eg.

Area between the Lorenz Curve and the 45° line
Total area below the 45° line

The resulting number ranges between:
0 = perfect equality where say, 1% of the population = 1% of income, and
1 = maximum inequality where all the income of the economy is acquired by a single recipient.

* The straight line (45° line) shows absolute equality of income. That is, 10% of the households earn 10% of income, 50% of households earn 50% of income.

The comparison before and after taxes and transfer gives an indication of how they benefit the levels of inequality in an economy.

America’s tax system is progressive and as the its pre-tax Gini coefficient is high the government has to spend more on transfer payments to reduce inequality. In contrast, countries with low pre-tax inequality, such as South Korea, manage to achieve low post-tax inequality without doing much by way of redistribution. Note that the graph from The Economist is on a scale of 0 – 100. 100 being maximum inequality.

The significance of government spending has a big impact on a country’s Gini coefficient. The Economist note that both France and the US have similar levels of inequality before tax but after taxes France reduces inequality from 45 to 28 whilst the US reduces it from 47 to 38 approximately. In France government spending accounts for 57% of GDP. America’s federal, state and local authorities spend just 35%.

New Zealand has a Gini coefficient of 42 whilst after taxes and transfers goes down to 34.

Ireland does most to slash inequality. After taxes and transfers, Ireland’s income distribution goes from 50 to 30 – the higher income groups pay more in tax than in most other countries, while low-earning households receive generous tax credits and transfer payments. Part of the reason Ireland is able to do so much redistribution is that it relies more than most on taxes paid by multinational companies. Foreign-owned firms accounted for 80% of corporate tax in 2017. Cross-country data suggest that if America wanted to bring its level of inequality down to the OECD average, it would have to boost government spending to 50% of GDP.

Source: The Economist – April 13th 2019.

62 individuals have same wealth as 3.5 billion people

An Oxfam report suggests that global inequality has reached levels not seen in over a century. The report stated that 62 individuals had the same wealth as the poorest 3.5 billion people. The wealth of those 62 people has risen 44 percent, or more than half a trillion dollars, over the past five years, while the wealth of the bottom half has fallen by over $1 trillion.

“Far from trickling down, income and wealth are instead being sucked upwards at an alarming rate,” the report says.

It points to a “global spider’s web” of tax havens that ensures wealth stays out of reach of ordinary citizens and governments, citing a recent estimate that $7.6 trillion of individual wealth — more than the combined economies of Germany and the U.K. — is currently held offshore.

Lorenz Curve

The Lorenz curve is a useful tool used by those interested in statistics and economics to give a picture of distribution. Its plots the % of household income on the vertical scale against the % of households on the horizontal. An example is shown rightLorenz 2.

The Gini Coefficient is derived from the same information used to create a
Lorenz Curve. The co-efficient indicates the gap between two percentages: the percentage of population, and the percentage of income received by each percentage of the population. In order to calculate this you divide the area between the Lorenz Curve and the 45° line by the total area below the 45° line eg.

Area between the Lorenz Curve and the 45° line / Total area below the 45° line

The resulting number ranges between:
0 = perfect equality where say, 1% of the population = 1% of income, and
1 = maximum inequality where all the income of the economy is acquired by a single recipient.

* The straight line (45° line) shows absolute equality of income. That is, 10% of the households earn 10% of income, 50% of households earn 50% of income.

* The Lorenz Curve itself shows actual distribution of income. The further the Lorenz Curve is away from the 45° line, the more unequal is the distribution of income. With the recent Oxfam report the inequality line has moved further to the right.

* Lorenz Curves are typically drawn from gross income. Once disposable income is taken into account, the Lorenz Curve will most likely move inwards. This is because, as we shall see, the net effect of taxes and other distributional measures of government is to bring everyone’s disposable incomes closer together.

* Those countries where the wealth is in the hands of a few, such as oil sheikdoms, will have Lorenz Curves extremely bowed.

Lorenz curves may also be drawn to show the extent of inequality in the distribution of wealth. Such curves are likely to be even further away from the line of complete equality than are those of the distribution of income. This is because most people have some disposable income while not everyone has assets.

Tools of Redistribution

If we are concerned with how well-off people are and how much inequality there is, looking only at individual or household disposable income is not enough. It is not simply a matter of how much cash income the government leaves us with. The use of taxes and transfers may be the main way of directly redistributing income, but this is not the only way by which government can influence well-being. A combination of approaches can better tackle the problem. In general we may consider that government influences the extent of inequality by:

• The way in which it raises taxes to pay for public goods that everyone has such as defence and parks. The tax system may be designed to take more from the higher income groups, while everyone gets similar benefits from the public goods. More importantly tax dodging by the super-rich is one of the main drivers of global income inequality and needs to be sharply curtailed.

• Giving transfers, such as family support and the sickness benefit, to those whose income is very low or who cannot earn.

• Providing collective goods mainly to the lower income groups.

• Providing targeted subsidies or subsidies received only by those with low incomes&emdash; e.g., housing loans and education grants.

• Providing general subsidies on basic goods such as bread, milk, GP services and electricity. These used to be far more important than they are today. Subsidies have the problem that they encourage waste.

• Ensuring that all employers pay a fair wage under minimum pay, equal pay and pay equity legislation.

• Ensuring that everyone has equality of opportunity. Those who wish to proceed to tertiary education, for example, should be given the opportunity.

• Encouraging training and acquisition of skills by all school leavers.

US Inequality – top 0.1% closing in on bottom 90%

Inequality in wealth in the USA is approaching record levels. Research by Emmanuel Saez of the University of California, Berkeley, and Gabriel Zucman of the London School of Economics examined the share of total wealth held by the bottom 90% of families relative to those at the very top – 0.1%. Their research in wealth distribution reveals three trends:

1. Wealth inequality appears to have followed a U-shape evolution since 1913, with a marked increase since the 1980s. By their estimates, virtually all the increase in the top 10% and top 1% shares over the last three decades is due to the rise in the top 0.1% share, from 7% in the late 1970s to 22% in 2012.

2. The wealth share of the bottom 90% has followed an inverted-U evolution: from a low point of 15% in the late 1920s and at the beginning of the Great Depression, it steadily rose to 35% in the mid-1980s—thanks to rising pension and housing wealth—but then dropped to 23% in 2012 because of an increase in mortgage and other debts.

3. The increased concentration of wealth at the top seems driven by surging top incomes. The combination of increasing income inequality with increasing saving rate inequality is fueling wealth inequality

The Economist produced a very good interactive graphic on this entitled – Some are more equal than others – see the screenshot below. Useful for Unit 5 of the A2 course that looks at the Lorenz Curve.
Inequality US 90 percent

US Distribution of Income by Source

From Matthew Yglesias business and economics correspondent of Slate magazine. The graph below shows the lorenz curve with different types of income. Some key points:

1. Distribution of capital income is much more unequal than the distribution of wage income
2. Distribution of business income looks exactly like the distribution of capital income.
3. Capital income is unequally distributed because wealth itself is very unequally distributed.

These points all matter because they point to the existence of two different axes of inequality. One is the wage gap between the high earners and the low or median earners. But the other is the traditional class conflict between the people whose earnings are dominated by work and the people whose earnings are dominated by wealth-possession. In particular, a structural shift in the economy to become less favorable to people who work for a living (including rich people like King James) in favor of people who own things (including the relatively modest fortunes of “middle-class” retirees living off accumulated savings) isn’t necessarily going to do anything to the wage-distribution curve. And yet the clash between peasants and landowners, between factory workers and factory owners, and now between people cheered by the S&P recovery and those saddened by the wage slump is probably the more significant political issue.

Lorenz Curve labour capital etc

Global Inequality

Some interesting facts in this video regarding global inequality. Particularly useful if you are covering the Lorenz Curve – notice the shape in the video. The richest 300 people in the world have the same wealth as the poorest 3 billion. The world is more unequal than at any time in history – 200 years ago everyone was poor. A small number of countries have achieved economic growth and been able to create jobs and raise the standard of living. However those countries represent only about 15% of the global population whilst 85% is what we call the developing world.

Inequality and Efficiency

The Economist last year did a special report on the ‘World Economy’ focusing on the growing inequality. An area that was addressed was the trade-off between inequality and efficiency.

Last century inequality was seen as essential for investment and growth because rich people save more.

John Maynard Keynes – “precisely the inequality of the distribution of wealth which made possible those vast accumulations of fixed wealth and of capital improvements which distinguished [the Gilded Age] from all others”

Milton Friedman – stated that greater inequality would encourage people to work harder and improve productivity.

Gary Becker – inequality encourages people to invest in their education. Redistribution, in contrast, brings inefficiencies as higher taxes and government handouts deter hard work. The bigger the state, the greater the distortion of private incentives.

In China and India it has been freedom and better incentives that have been integral to economic growth, however some of the inequality that is apparent today is inefficient rather that growth promoting. The Economist came up with various reasons:

1. Countries with the biggest income gaps, increasing inequality is partly a function of rigidities and rent-seeking—be it labour laws in India, the hukou system and state monopolies in China or too-big-to-fail finance in America. Such distortions reduce economies’ efficiency.

2. Rising inequality has not, by and large, been accompanied by a smaller (and hence less distortive) state. In many rich countries government spending has risen since the 1970s. The composition has changed, with more money spent on the health care of older, richer folk, and relatively less invested in poorer kids. Modern transfers are both less progressive and less growth-promoting.

3. Recent experience from China to America suggests that high and growing levels of income inequality can translate into growing inequality of opportunity for the next generation and hence declining social mobility. That link seems strongest in countries with low levels of public services and decentralised funding of education. Bigger gaps in opportunity, in turn, mean fewer people with skills and hence slower growth in the future.

The area of inequality and social mobility showed that the USA’s GDP growth was inversely correlated with their inequality of opportunity, but not with overall inequality. Known as the “Great Gatsby Curve” (see below) this suggests that countries with higher Gini coefficients tend to have lower inter-generational social mobility.

Great Gat Curve

Visual Economics website

Here is a useful website with a potpourri of images that can be used to explain theory with current data – Visual Economics. Below is a graphic explaining the lorenz curve – CIE A2 and NCEA 3.3. There are loads of other topics including:
* How The Average U.S. Consumer Spends Their Paycheck
* Healthcare Costs Around the World
* GDP vs National Debt by Country
* The Anti-Fed Fact Sheet
* Unemployment Rates Around The World