The Treasury

Global Navigation

Personal tools

5  Conclusions

The aim of this paper has been to emphasise the need to avoid spurious comparisons of inequality and poverty by paying particular attention to the choice of welfare metric (or income concept) and unit of analysis. A wide range of possible distributions can be constructed so that great care is needed when making comparisons. It is especially important to make explicit the various value judgements that are inevitably involved.

The paper has concentrated on clarifying the nature of alternative distributions, rather than examining the more technical issues relating to formal measures of inequality, on which there is a vast literature.

In the literature on inequality measurement, many analytical results regarding inequality and tax progressivity have been developed in the context of populations consisting of individuals receiving different (exogenous) incomes but otherwise being identical. It was found possible to make important connections between clearly stated value judgements, such as the principle of transfers, and comparisons of Lorenz and Generalised Lorenz curves. Widely used inequality measures could be linked explicitly to value judgements and associated social welfare (or evaluation) functions. However, in practice the need to deal with heterogeneous individuals and households, combined with the sharing of resources within households, has meant that applied economists typically deal with somewhat artificial income concepts as well as income units.

When the artificial income concept of household income per adult equivalent is used, a similarly artificial unit, the equivalent adult, needs to be used as the unit of analysis if it is desired to apply all the established welfare results regarding Lorenz curves and the principle of transfers. But if an anonymity principle - the value judgement that all individuals should ‘count as one' irrespective of the household to which they belong - is instead held, the appropriate unit is the individual. However, in this case the principle of transfers can no longer be relied on: indeed it is possible for such an approach to be inequality preferring if rich large households are judged to benefit from large economies of scale.

Instead of using equivalence scales where equal sharing is implicit, an explicit sharing rule could be used to allocate total household income among household members. This can be further extended to allow for the assignment of some government expenditure to individuals: thus the expenditure is assumed to involve publicly funded private goods. It must be recognised that results can depend on the sharing rule assumed, and of course the application of a common sharing rule to all households is a strong assumption. Furthermore, a comparison of final income with market income involves the artificial income measure obtained by applying the same sharing rule to market incomes.

It has also been shown that income distribution comparisons over time, and particularly evaluations of tax policy changes, need to be made with care. This is because both the population structure (and thus the pre-tax income distribution) and the tax policy are subject to changes. However, the marginal effects of each change can be computed based on a range of decomposition analyses.

Despite the many problems, there will undoubtedly continue to be much interest in inequality and the redistributive role of government. There will therefore continue to be a strong demand for the empirical evaluation of policies in terms of their effects on inequality. Policies which are designed for quite different purposes may be thought to have implications for inequality that need to be explored. Hence applied economists cannot afford to be nihilistic. A substantial amount of pragmatism, using measures and approaches that have known limitations, is needed in the face of considerable complexity and fundamental difficulties, including data and modelling limitations.

It is therefore extremely important to be as clear as possible about the approach used, to provide a wide range of results to allow readers to use their own judgement, and to exercise caution in interpreting results.

A final additional word of caution is perhaps also warranted. Even if concern were purely with market incomes which unambiguously involve the individual as the unit of analysis, assessing the impact of taxation is not straightforward, in view of endogeneity effects involved. In particular, the tax and transfer structure is designed to allow for differences in the demographic structure of households, and individual incomes are affected by joint labour supply decisions of partners. Household formation and fertility are jointly determined, along with labour supply. Thus pre-tax incomes themselves depend on the tax structure, so the term ‘redistributive effect of taxes' must be used with caution. Importantly, a tax change designed to be more redistributive may in fact lead to lower inequality of post-tax incomes, but also to higher inequality of pre-tax incomes.

Page top