The Visible Hand of the Government

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Dr. Periklis Gogas,Professor of Economic Analysis and International Economics

 

 

Emmanouil Sofianos, Ph.D. candidate

 

 

Department of Economics, Democritus University of Thrace, Greece

Following the financial crisis and the great recession of 2008, income inequality has become a key concern for economists, governments and policy makers in most developed countries. Many believe that taxation may be unfair and ineffective. One of the main issues is that the taxation system and the redistribution of income through allowances, benefits and various transfers, instead of mitigating income inequality it is actually making the poor poorest and rich richer. Several recent estimates show what Oxfam (a development charity organization) stated earlier this year: in 2018, the world’s 26 richest billionaires own the same value of assets as the poorest 50% of the world population, i.e. 3.5 billion people. This number was 43 in 2017 and 61 in 2016, providing evidence of a growing gap between the rich and poor.

In this article we highlight the important role of the government through taxation and redistribution of income in tackling poverty, inequality and providing better opportunities especially for the unlucky. It is interesting to see how well governments around the world achieve this goal. We focus on the results of a recent analysis published by the Economist and that was based on OECD and IMF data on the effect of taxes and transfers on the Gini coefficient. The Gini coefficient (or Gini index) is a statistical measure of distribution developed by the Italian statistician Corrado Gini in 1912. The index ranges from 0% to 100%. At 0% we all get the same income and at 100% one individual gets all income generated in the economy. Thus, achieving a lower Gini index is a sign of decreased inequality.

In the following graph we can see the Gini index for each OECD country before and after government redistribution of income through taxes, transfers and social aid programs. On the horizontal axis at the top we see the Gini without any government redistribution. Below we see the reduction in inequality that is the result of government taxes and social programs. A line connects the two indices for each county to highlight the effect. This line is presented in red for the U.S. The before value is at 47% and the government brings this down to 38% a drop of 9 percentage points. Ireland has the highest pre-government inequality at 50% but also the greatest reduction in

inequality by 20 points to 30%. South Korea on the other hand starts very low at 31% but government reduces this by a mere 4 points to 27%. Greece has the third heist pre-government inequality at approximately 48% after Ireland, Mexico and Chile. Nonetheless, even after the debt crisis and almost 10 years in recession that resulted in a shrinking government sector where many transfer policies were redefined towards less spending, it manages to reduce inequality by 14 points. Other notable examples are France that goes from 45% to 29%, Finland from 43% to 27% and Slovenia from 39% to 24%.

 

Several conclusions can be drawn from this chart:

· The role of government is significant across all OECD countries. It redistributes income and manages to reduce inequality in all OECD economies.

· There are two outliers like Mexico and Chile where the Gini coefficient is reduced only by 2-3 points after government intervention.

· Nonetheless, for the vast majority of countries the resulting Gini is lowered by 10 to 15 points.

· Given that the wealthiest own more of the world’s wealth each year, these government income redistribution programs, although effective they must be more aggressive.

· This is especially important for developing countries where inequality is higher.

· The developed countries that are members of the OECD prove that reduction in inequality is possible with the implementation of appropriate and maybe more aggressive government taxation and transfer programs.

References: https://www.theguardian.com/business/2019/jan/21/world-26-richest-people-own-as-much-as-poorest-50-per-cent-oxfam-report https://www.economist.com/finance-and-economics/2017/10/19/higher-taxes-can-lower-inequality-without-denting-economic-growth

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