Econ 551 Government Finance: Revenues Fall 2019 Given by Kevin - PowerPoint PPT Presentation

Econ 551 Government Finance: Revenues Fall 2019 Given by Kevin Milligan Vancouver School of Economics University of British Columbia Lecture 2a: Redistribution and Social Choice ECON 551: Lecture 2a 1 of 42

Agenda: 1. How unequal are incomes? 2. Does government have a role? 3. Social welfare functions 4. Axiomatic approach: Arrow’s impossibility theorem. ECON 551: Lecture 2a 2 of 42

Inequality in Canada: Four trends Two of these trends suggest: ‘this isn’t such a problem’… i) Median incomes are growing ii) Low-income levels are improving …but digging deeper reveals some cause for concern. iii) Earnings stagnation iv) Income concentration at top Similar trends happening in some other advanced countries. (See Atkinson, Piketty, and Saez 2011 JEL) For Canada inequality trends, see Fortin Green Lemieux Milligan Riddell (2012) or Corak (2016). ECON 551: Lecture 2a 3 of 42

Canadian Trend #1: Median incomes moving up ECON 551: Lecture 2a 4 of 42

Canadian Trend #2: Low income: diverging measures … ECON 551: Lecture 2a 5 of 42

Canadian Trend #3: Earnings polarization hitting median males ECON 551: Lecture 2a 6 of 42

Role of the resource boom…. ECON 551: Lecture 2a 7 of 42

Canadian Trend #4: Income concentration at the top What is ‘the top 1%?’ Income (2015) you need to be in the top… Group Income needed Percentile Top 0.01 percent 3,636,000 P99.99 Top 0.1 percent 826,800 P99.9 Top 1 percent 234,700 P99 Top 5 percent 120,100 P95 Top 10 percent 92,800 P90 Top 50 percent 33,400 P50 Total individual income. Source: CANSIM 11-10-0055-01 Income shares: How much of the total pie of income goes to people in each of these groups? ECON 551: Lecture 2a 8 of 42

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300.0 High Income Shares 1982-2016 Indexed to 1982=100 275.0 266.7 Source: CANSIM 11-10-0055-01 250.0 Income Share indexed to 1982=100 225.0 215.0 P99.99 200.0 P99.9 P99 P95 175.0 Bottom 95 157.7 150.0 150.0 145.0 127.7 125.0 117.8 100.0 93.4 95.8 75.0 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 ECON 551: Lecture 2a 10 of 42

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Veall (2012): Big change in composition of top incomes  Very big swing in wage earners vs capital earners in top 0.01%.  Also note that proportion of wage income is ~same in top 0.01% and top 1% in 2009. o It is ‘supermanagers’ driving the concentration trend; not capital income. ECON 551: Lecture 2a 13 of 42

FGLMR (2012): Characteristics of the top 1% in 2005 ECON 551: Lecture 2a 14 of 42

Agenda: 1. How unequal are incomes? 2. Does government have a role? 3. Social welfare functions 4. Axiomatic approach: Arrow’s impossibility theorem. ECON 551: Lecture 2a 15 of 42

Should government ‘undo’ the market income distribution? What should government do?  Nothing (aka anarchy)  Enforce contracts (aka the ‘night watchman state’)  Provide public goods  Social Insurance  Redistribution In Canada, the federal government spends  ~45 % of its budget on ‘public goods’ (generously defined).  ~55% of its budget on transfers to individuals (30%) / other governments (25%). ECON 551: Lecture 2a 16 of 42

Concepts of fairness Procedural Justice: what matters is a fair process. Consequential Justice: what matters is a fair outcome. Sen (1995 AER): You can’t separate these two concepts.  If ‘fair’ procedure led to horrific outcome, we likely wouldn’t like that.  If a fantastic outcome were only available through something horrible like torture or death, we might not like that. Amartya Sen ECON 551: Lecture 2a 17 of 42

Perceptions of fairness: Alesina and Angeletos (2005 AER) See also Lefgren et al. (2016) and Weinzerl (2017) for experimental/survey evidence. ECON 551: Lecture 2a 18 of 42

Perceptions of fairness: Luttmer and Singhal (2011) ECON 551: Lecture 2a 19 of 42

The Rawls (1971) experiment John Rawls “A Theory of Justice” (1971)  A book about a ‘social contract’.  Imagine we chose how much redistribution there would be in society before we got to see our own position in the distribution.  In Rawls’s language, imagine we are behind a ‘veil of ignorance’ in the ‘original position.’  Rawls deduced that in this case, we should choose ‘maxi - min’, which maximizes the outcomes of those at the bottom. ECON 551: Lecture 2a 20 of 42

Rawls ’s critics Nozick “Anarchy, State, and Utopia” (1974) offers point-by-point rebuttal along libertarian lines.  Incomes belong to individuals; not ‘society’.  ‘Society’ has no right to redistribute because ‘society’ doesn’t own anything.  If outcomes are unequa l, that doesn’t matter.  What matters is the process that generates the outcomes. If process is fair, then outcomes are fair. (i.e. procedural justice) Also:  H ow much do we know behind ‘veil of ignorance’? Our abilities? The distribution of abilities? The distribution of outcomes? How much is ‘luck’ how much is ‘hard work’? ECON 551: Lecture 2a 21 of 42

Redistribution might be efficient: Boadway and Keen (2000) Boadway and Keen (2000) offer a survey of theories of redistribution. They also offer some reasons why redistribution can be efficiency enhancing.  Incomplete markets for insurance — redistribution acts as insurance to fill missing markets; improve efficiency.  Risk-sharing induces more risky investment  Government is ‘silent partner’.  Needs full loss- offset for the math to work, though… Other arguments have been made as well:  Inefficient investment in children; human capital. See e.g. Corak (2013) ECON 551: Lecture 2a 22 of 42

Agenda: 1. How unequal are incomes? 2. Does government have a role? 3. Social welfare functions 4. Axiomatic approach: Arrow’s impossibility theorem. ECON 551: Lecture 2a 23 of 42

Social Choice  There are lots of points on the contract curve: They are all efficient.  How to choose among them?  Subfield of ‘Social Choice’ draws on philosophy, mathematics, and economics.  For deeper treatment of the topics, see Mueller (2003) ch. 23 and Blackorby and Bossert (2004). ECON 551: Lecture 2a 24 of 42

Real-valued Social Welfare Functions Basic form was developed by Bergson (1938) and Samuelson (1947) Say we have  Individuals ℎ , from 1 to H .  Each individual has a utility function 𝑉 ℎ . Definition: A social welfare function is a function W such that: 𝑋 = 𝑋(𝑉 1 , 𝑉 2 , … , 𝑉 𝐼 ) That’s it. ECON 551: Lecture 2a 25 of 42

Comments on real-valued Social Welfare Functions (See Mueller ch. 23 for criticisms)  How do we evaluate 𝑉 ℎ ? Interpersonal utility comparisons? Is that informationally possible? If so, is it ethical?  An omniscient ruler might be able to see all of our 𝑉 ℎ and plug them in. Who gets that job?  Alternative interpretation: it’s all one person, just in different states of the world. Now it’s just intrapersonal utility comparisons.  Note that we can abandon the Pareto criterion and explicitly trading off individuals here.  How to choose which functional form for W ?  Several have been proposed….. ECON 551: Lecture 2a 26 of 42

Benthamite / Utilitarian Social Welfare Function Bentham and Mill most strongly associated with utilitarianism. Bentham: we can use a ‘hedonic calculus’ to ascertain the sum total of pleasure and pain produced by an act. 1 𝑂 ∑ 𝑉 ℎ 𝑋 = In math, . ℎ ECON 551: Lecture 2a 27 of 42

Benthamite / Utilitarian Social Welfare Function 𝜖𝑉 2 𝜖𝑋 = 𝜖𝑉 1 + 𝜖𝑉 2 = 0 implies 𝜖𝑉 1 = −1 . Graph on ‘social indifference map’ U 2 Slope= -1 U 1 Here, individuals are ‘perfect substitutes’. (Sen 1995: any weight on liberty? Is slavery ok? Violence? Torture?) ECON 551: Lecture 2a 28 of 42

‘Rawlsian’ Social Welfare Function The Rawlsian result: maxi-min. ℎ 𝑉 ℎ 𝑋 = max min U 2 U 1 Here, people are ‘perfect complements’. Society not better off unless the ‘min’ guy gets more, no matter how much other guy is getting. ECON 551: Lecture 2a 29 of 42

Atkinson’s Generalized Social Welfare Function 1 1 − 𝛿 ∑[(𝑉 ℎ ) 1−𝛿 − 1] 𝑋 = ℎ When 𝛿 = 0 , this collapses to Benthamite SWF. When 𝛿 = ∞ , this collapses to Rawlsian SWF. In between those points, 𝛿 governs the degree of curvature; of trade-off between individual utilities. ECON 551: Lecture 2a 30 of 42

Atkinson and Stiglitz Question Mark Diagram 𝑂 ′ • • • C N 45 ° line J • W • T Slope = -1 • R • Utility Person 2 E • P Utility Person 1 ECON 551: Lecture 2a 31 of 42