Taxes, Transfers,

Inequality and the Poor in the Developing World

Nora Lustig

Tulane University; CGD and IAD www.commitmentoequity.org

Lustig, Nora. 2014. “Taxes, Transfers, Inequality and the Poor in the Developing World. Round 1.” CEQ Working Paper No. 23, Center for Inter-American Policy and Research and Department of Economics, Tulane University and Inter-American Dialogue

CEQ Workshop

Accra, Ghana, June 17, 2014

1

CEQ Teams (Year of Survey; C=consumption & I=income)(MWB Version)

1. Armenia (2011; I): Stephen Younger and Artsvi Khachatryan (March 12, 2014; paper)

2. Bolivia (2009; I): Veronica Paz Arauco, George Gray-Molina, Wilson Jimenez and Ernesto Yañez (CEQ Web Dec 2013) Public Finance Review, May 2014, Volume 42, Issue 3

3. Brazil (2009; I): Sean Higgins and Claudiney Pereira (CEQ Web Dec 2013) Public Finance Review, May 2014, Volume 42, Issue 3

4. Costa Rica (2010; I): Pablo Sauma and Juan Diego Trejos (February 2014; paper)

5. El Salvador (2011; I): Margarita Beneke, Nora Lustig and Jose Andres Oliva (March 11, 2014)

6. Ethiopia (2010/11; C): Ruth Hill, EyasuTsehaye, Tassew Woldehanna (April 30, 2014)

7. Guatemala (2011; I): Maynor Cabrera, Nora Lustig and Hilcias E. Moran (April 13, 2014)

8. Indonesia (2012; C) : Jon Jellema and Matthew Wai-Poi (February 18, 2014)

2

CEQ Teams (Year of Survey; C=consumption & I=income)(MWB Version)

9. Jordan (2010; C) : Morad Abdel-Halim, Shamma Adeeb Alam, Yusuf Mansur, Umar Serajuddin, Paolo Verme (April 18, 2014)

10. Mexico (2010; I): John Scott (CEQ Web Dec 2013) Public Finance Review, May 2014, Volume 42, Issue 3

11. Peru (2009; I): Miguel Jaramillo (CEQ Web Dec 2013) Public Finance Review, May 2014, Volume 42, Issue 3

12. South Africa (2010; I): Ingrid Woolard, Precious Zikhali, Mashekwa Maboshe, Jon Jellema (May 5, 2014)

13. Sri Lanka (2009/10; C): Nisha Arunatilake, Gabriela Inchauste and Nora Lustig (April 8, 2014; paper)

14. United States (2011; I): Sean Higgins, Nora Lustig, Whitney Ruble and Timothy Smeeding

15. Uruguay (2009; I): Marisa Bucheli, Nora Lustig, Maximo Rossi and Florencia Amabile (CEQ Web Dec 2013) Public Finance Review, May 2014, Volume 42, Issue 3

• Research Assistant: Yang Wang, Tulane University

3

Message to Viewers and Users

• Data is still under review except for Bolivia, Brazil, Costa Rica, Guatemala, Mexico, Peru and Uruguay

• Except for what is published in CEQ website or other places, information can be cited with permission only

If permission to cite is granted please use the following: • Lustig, Nora. 2014. “Taxes, Transfers, Inequality and the

Poor in the Developing World. Round 1” CEQ Working Paper No. 23, Tulane University and Inter-American Dialogue.

• AND, please cite the authors and date of submission for each country as noted in “CEQ Teams.”

4

Outline

• Governments come in all sizes

– Primary Spending and GDP: outliers everywhere – Composition of Social Spending: hello diversity – Composition of Tax Revenues: again, hello diversity, but…

• Taxes, Transfers and Inequality: Robin Hood, or Robin Hood Paradox? (Lindert, 2006) – How do consumption taxes affect redistribution?

• Taxes, Transfers and Poverty Reduction: much less auspicious

• A glimpse at Ethiopia 5

Countries are heterogeneous => same income/capita & different government sizes => same government size & different income/capita

0

2000

4000

6000

8000

10000

12000

14000

16000

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Primary and Social Spending to GDP (ranked by GNI/capita in ppp 2005 US$; right hand scale)

Social Spending/GDP Primary Spending/GDP

GNI per capita6

However, both the size of government and social spending rise with income/ capita…

BOL

BRA

CRI

SLV

GTM

MEX PER

URY

AMR

ETH

IND

JOR

ZAF

LKA

BOL

BRA CRI

SLV

GTM

MEX

PER

URY

AMR ETH

IND

JOR

ZAF

LKA

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

0 2000 4000 6000 8000 10000 12000 14000 16000

GNI/Capita

Primary and Social Spending vs GNI/capita

Primary Spending/GDP Social Spending/GDP7

Size and composition of social spending is quite heterogeneous…

0

2000

4000

6000

8000

10000

12000

14000

16000

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Composition of Social Spending (does not include contributory old-age pensions)

(ranked by GNI/capita; right hand scale )

Direct Transfer/GDP Education/GDP Health/GDP Subsidies/GDP GNI per capita

8

As expected, size and composition of taxes is heterogeneous too

Note: Direct Taxes include PIT and contributions to social security; Indirect Taxes include VAT, excise and other consumption taxes depending on the country.

Dashed Line: Average Indirect Taxes 9 percent Solid Line: Average Direct Taxes 6 percent

0

2000

4000

6000

8000

10000

12000

14000

16000

0%

5%

10%

15%

20%

25%

30%

Composition of Taxes (ranked by GNI/capita; right hand scale )

Direct Tax/GDP Indirect Tax/GDP GNI per capita

9

=> Share of Direct Taxes increases with the size of the economy => Share of Consumption Taxes does not

0%

5%

10%

15%

20%

25%

30%

0 2000 4000 6000 8000 10000 12000 14000 16000

GNI/capita

Taxes/GDP vs. GNI/capita

Direct Tax/GDP Indirect Tax/GDP Total Tax/GDP

10

Outline

• Governments come in all sizes – Primary Spending and GDP: outliers everywhere – Composition of Social Spending: hello diversity – Composition of Tax Revenues: again, hello diversity, but…

• Taxes, Transfers and Inequality: Robin Hood, or Robin Hood Paradox? (Lindert, 2006) – How do consumption taxes affect redistribution?

• Taxes, Transfers and Poverty Reduction: much less auspicious

• A glimpse at Ethiopia 11

Redistribution in the rich and developing countries

Sources: Immervoll et al. (2009) for EU, Higgins et al. (2013) for USA, and for CEQ countries see slide 3.

Note: in these calculations contributory pensions are part of market income and NOT treated as a government transfer.

-0.18

-0.16

-0.14

-0.12

-0.10

-0.08

-0.06

-0.04

-0.02

0.00

Ind

on

esi

a

Gu

ate

ma

la

Sri

La

nk

a

El

Sa

lva

do

r

Bo

liv

ia

Peru

Eth

iop

ia

Jo

rd

an

Co

sta

Ric

a

Mex

ico

Arm

en

ia

Uru

gu

ay

Bra

zil

(p

er

ca

pit

a)

Bra

zil

(eq

uiv

ali

zed

)

So

uth

Afr

ica

Gre

ece

US

Ita

ly

Po

rtu

ga

l

Sp

ain

Neth

erla

nd

s

Fra

nce

Au

stria

Germ

an

y

Sw

ed

en

Lu

xem

bo

urg

Belg

ium

UK

Fin

lan

d

Den

ma

rk

Irela

nd

Change in Gini: Disposable vs. Market Income (in GINI points)

Developing Countries (CEQ 14)

Rich Countries

12

Zooming in (CEQ 14 countries)

-0.08

-0.07

-0.06

-0.05

-0.04

-0.03

-0.02

-0.01

0.00

Change in Gini: Disposable vs. Market Income (in GINI points)

13

Redistribution rises with income per capita

BOL

BRA

CRI

SLV GTM

MEX

PER

URY AMR

ETH

IND

JOR

ZAF

LKA

0.00

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

0 2000 4000 6000 8000 10000 12000 14000 16000

GNI/Capita

Change in Gini: Disposable vs Market (decline in Gini points shown in positive quadrant)

14

Rich and developing countries together: Robin Hood paradox => more inequality => less redistribution…

Note: CEQ 14 countries, EU countries, CEQ US are all included.

0.00

0.02

0.04

0.06

0.08

0.10

0.12

0.14

0.16

0.18

0.30 0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0.75

Mkt Income Gini

Change in Gini: Disposable vs. Market Income (decline in Gini points shown in positive quadrant)

15

…but in rich countries a mild Robin Hood

Note: CEQ countries, EU countries, US are all included. Decline is in Gini points.

GRC USA

ITA

PRT

NLD

ESP FRA

AUT DEU SWE

LUX

BEL UK FIN

DNK

IRL

0.06

0.08

0.10

0.12

0.14

0.16

0.18

0.30 0.35 0.40 0.45 0.50 0.55

Mkt Income Gini

Change in Gini: Disposable vs. Market Income (decline in Gini points shown in positive quadrant)

16

…in developing countries: the more unequal, the more redistribution =>Robin Hood is around

IND GTM SLV 0.01 PER

BOL

LKA

JOR

CRI MEX

ARM URY BRA

ZAF

0.00

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

0.30 0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0.75

Mkt Income Gini

Change in Gini: Disposable vs. Market Income (decline in Gini points shown in positive quadrant)

17

This is also true if we measure it by society’s “effort:” spending on transfers/GDP rises with inequality

IND PER

GUM

JOR

MEX

CRI ETH SLV

BOL LKA

URY

ARM

BRA

ZAF

0.00

0.01

0.01

0.02

0.02

0.03

0.03

0.04

0.04

0.05

0.05

0.30 0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0.75

Dir

ect

Tran

sfer

/GD

P

Mkt Income Gini

Direct Transfers/GDP vs. Mkt Income Gini

18

…and so does social spending/GDP

IND

PER GUM

JOR

MEX

CRI

ETH

SLV

BOL

LKA

URY

ARM

BRA

ZAF

0.00

0.02

0.04

0.06

0.08

0.10

0.12

0.14

0.16

0.18

0.20

0.30 0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0.75

Soci

al S

pen

din

g/G

DP

Mkt Income Gini

Social Spending/GDP vs. Mkt Income Gini

19

Note:

-0.08

-0.07

-0.06

-0.05

-0.04

-0.03

-0.02

-0.01

0.00

Change in Gini points: Post-fiscal vs. Market

20

Basic story does not change when you add the effect of consumption subsidies and consumption taxes

GTM BOL

IND

LKA SLV PER

ETH

CRI

JOR MEX ARM URY BRA

ZAF

0.00

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

0 2000 4000 6000 8000 10000 12000 14000 16000

GNI/Capita

Change in Gini: Post-fiscal vs. Market (decline in Gini points shown in positive quadrant)

21

Robin Hood stays around…

GTM BOL

IND LKA

SLV PER

ETH

CRI

JOR MEX ARM URY BRA

ZAF

0.00

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

0.30 0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0.75

Mkt Income Gini

Change in Gini: Post-fiscal vs. Market (decline in Gini points shown in positive quadrant)

22

Or, when you add (monetized) Education & Health

ETH

GUM LKA

IND

SLV

JOR

PER

ARM

BOL

MEX

URY

CRI

BRA

ZAF

0.00

0.05

0.10

0.15

0.20

0.25

0 2000 4000 6000 8000 10000 12000 14000 16000

GNI/Capita

Change in Gini: Final vs. Market Income (decline in Gini points shown in positive quadrant)

23

Again, Robin Hood stays around

ZAF

BRA

USA CRI

URY

MEX BOL ARM

PER JOR

SLV

IND

LKA GUM ETH

0.00

0.05

0.10

0.15

0.20

0.25

0.30 0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0.75

Mkt Income Gini

Change in Gini: Final vs. Market Income (decline in Gini points shown in positive

quadrant)

24

Outline

• Governments come in all sizes – Primary Spending and GDP: outliers everywhere – Composition of Social Spending: hello diversity – Composition of Tax Revenues: again, hello diversity, but…

• Taxes, Transfers and Inequality: Robin Hood, or Robin Hood Paradox? (Lindert, 2006) – How do consumption taxes affect redistribution?

• Taxes, Transfers and Poverty Reduction: much less auspicious

• A glimpse at Ethiopia 25

The Poverty Reduction story is broadly similar, when we look at what people get in disposable income…

Poverty in this slide and all subsequent ones is measured with the international line of US$2.50 ppp (2005) per day.

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

Change in Headcount Ratio: Disposable vs. Market Income

(in percentage points)

26

…however, story changes quite dramatically with Consumption Taxes …

Note: Post-fiscal income equals disposable income plus consumption subsidies minus consumption taxes

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

Change in Headcount Ratio (in percentage points)

Disposable vs. Market Post-fiscal vs. Market

27

Note: Positive number indicates a decline, all CEQ countries are included.

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

0 2000 4000 6000 8000 10000 12000 14000 16000

GNI/capita

Change in Headcount Ratio (decline in percentage points in positive quadrant)

Change in Headcount: Disposable vs. Mkt Change in Headcount: Post-fiscal vs. Mkt

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0 1 2 3 4 5 6 7 8 9 10

Mexico

Sri Lanka

Brazil

Bolivia

Uruguay

Armenia

Costa Rica

EI Salvador

Peru

Guatemala

Decile

Net Payers to the Fiscal System Start at Decile...

Net Payers

29

Outline

• Incidence Analysis: What is it? • Governments come in all sizes

– Primary Spending and GDP: outliers everywhere – Composition of Social Spending: hello diversity – Composition of Tax Revenues: again, hello diversity, but…

• Taxes, Transfers and Inequality: Robin Hood, or Robin Hood Paradox? (Lindert, 2006) – How do consumption taxes affect redistribution?

• Taxes, Transfers and Poverty Reduction: much less auspicious

• A glimpse at Ethiopia 30

Redistribution in Ethiopia is above prediction…

BOL

BRA

CRI

SLV GTM

MEX

PER

URY AMR

ETH

IND

JOR

ZAF

LKA

0.00

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

0 2000 4000 6000 8000 10000 12000 14000 16000

GNI/Capita

Change in Gini: Disposable vs Market (in GINI points)

31

Direct taxes AND consumption taxes are PROGRESSIVE (equalizing)

0

0.2

0.4

0.6

0.8

1

1.2

1 2 3 4 5 6 7 8 9 10 11

Market Income

Direct Taxes

Indirect Taxes

Total Taxes

32

However, except for the bottom 10 percent, all deciles are net payers to the fisc…

-0.15

-0.10

-0.05

0.00

0.05

0.10

0.15

0 1 2 3 4 5 6 7 8 9 10

Ethiopia: Net Payers to the Fiscal System Start at Decile...

33

Except for the bottom income category (<US$1.25/day), the rest are net payers to the fisc…

-0.25

-0.20

-0.15

-0.10

-0.05

0.00

0.05

y < 1.25 1.25 < = y < 2.50 2.50 <= y < 4.00 4.00 <= y < 10.00 10.00 <= y < 50.00 50.00 <= y

Ethiopia: Net Payers to the Fiscal System Start at Income Category...

34

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Market Income Net Market Income Disposable Income Post-fiscal Income

Ethiopia: Headcount Ratios

National Moderate PL $1.24 PPP National Extreme PL $0.65 PPP

In Ethiopia, post-fiscal poverty is higher than pre-fisc poverty even when using the official US$1.24 (daily ppp) “moderate” poverty line

35

Main Take Aways

• Government size (primary spending as a share of GDP) is quite heterogeneous but—on average-- it increases with per capita income

• Ditto Social Spending

• Composition of Social Spending and Taxes is also heterogeneous but, as expected, Consumption Taxes are—on average- 50 percent higher (as a share of GDP) than Direct Taxes

36

Main Take Aways

INEQUALITY

• When rich and developing world are combined, the more unequal, the less redistributive (Robin Hood Paradox)

• However, when separated, Robin Hood is around, especially for the developing world

• This result is true for disposable and post-fiscal income

37

Main Take Aways

POVERTY

• The combination of direct taxes and cash transfers reduce poverty around 2 percentage points on average

• However, when the effect of consumption taxes (net of subsidies) is taken into account, poverty (with the US2.50/day line) IS HIGHER than pre-fisc poverty in 6 out of 14 countries

• Net payers to the fisc can begin as low as the second decile

38

Main Take Aways

ETHIOPIA

• Reduction in inequality is above that expected for its income per capita

• However, when the effect of consumption taxes (net of subsidies) is taken into account

Net payers to the fisc start in the SECOND decile and in the income group between US$1.25 and US$2.50/day

Poverty (with the US$1.2439/day line) IS HIGHER than pre-fisc poverty

39

Thank you!

40