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The Haves and Have-Nots -- Why the Wealthy Tend to Keep Getting Richer at Our Expense

Economist Branko Milanovic explains why the middle class inevitably fails to reap the benefits of fiscal redistribution.
 
 
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The following is an excerpt from Branko Milanovic's new book, The Haves and the Have-Nots: A Brief and Idiosyncratic History of Global Inequality(Basic Books, 2010).

Who Gains from Fiscal Redistribution?

When we speak of income distribution, we almost invariably have in mind the distribution of what in economics is called “disposable income.” As the name says, this is income that remains at the disposition of households to save or spend, after they have paid direct taxes to the government and received from the government cash benefits like social security and unemployment compensation. But there is another income concept that is, at times, useful. This is “market income,” which is income received from wages, profits, interest, rent, and so forth, before fisc (that is, before either taxation or receipt of government transfers).

Obviously, people with very low market income will be people who either are unable (or unwilling) to sell their labor services and lack property from which they could derive some income. Oftentimes, in developed countries, they are the unemployed. Incidentally, state-funded pensions (like social security) or private pensions are considered equivalent to wage payments (only delayed) and thus included in market income.

Having thus set the stage, this question is often asked: What income groups benefit the most from government redistribution (taxes and cash benefits)? There is a theory that says that in democracies, where people vote on redistributive policies, the main beneficiaries should be people in the middle of (market) income distribution. The rationale is as follows. Suppose there are three people with their market incomes being, respectively, low, medium, and high. (Market income is important here because you decide on tax-and-spend policies you prefer based on the market income you have earned.) The poor person will tend to prefer high tax rates and a lot of government spending because he is likely to benefit from it.

For exactly the opposite reason, the rich person will prefer low tax rates. Then the pivotal vote is held by the person in the middle. With whomever he aligns, that side wins two to one. The median voter, or what we may call “the middle-class voter,” becomes the decisive voter. We would in principle expect him to gain through the process of redistribution. He may not gain more than the poor because tax rates are generally progressive (that is, they increase as market income goes up), but, for sure, we would expect that the middleclass voter would gain in the process of redistribution since, after all, he chooses the tax rate and the benefits that go with it. That means that he would be better off when measured in terms of disposable than in terms of market income. Is this the case?

As it turns out, not exactly, and not unambiguously. First, we find that it is the poor who gain the most from redistribution. Their income share, which is generally tiny in terms of market income, increases, after government redistribution, to still small but more reasonable. For example, in major democracies studied over the period 1980–2000, the share of the poorest decile (10 percent of the population) in total market income is very small, only 1.2 percent. After government redistribution the income share of these same people rises, on average across countries, to 4.1 percent. The poorest decile thus gains almost 3 percentage points. The equivalent numbers for the second-poorest decile are 3.6 and 5 percent. The gain here is 1.4 percent. For each successive (richer) decile, the gains diminish, until they turn to be slightly negative for the fifth and sixth deciles, and then, of course, continue to be even more negative for the higher deciles. Gains are not the same in all countries.

 
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