Allocation of Government Expenditure Influences Measure of Inequality


ZEW Study Shows that Piketty Study Overstates Level of Inequality

ZEW Study Shows that Piketty Study Overstates Level of Inequality

How evenly do countries distribute their expenditure among its citizens? To explore this question, it is necessary to look not only at direct government spending such as social transfers or child benefits, but also at in-kind benefits such as public spending on education, infrastructure and defence. ZEW Mannheim shows that the extent of inequality of post-tax income depends strongly on the distribution of these expenditures and that the famous study by Piketty and his co-authors overstates the level of inequality.

The question of equal income distribution in a country is a concern for policymakers and economists alike. In 2018, economists Thomas Piketty, Emmanuel Saez and Gabriel Zucman published a well-received paper in which they presented a method to measure the distribution of US national income among individual citizens. They constructed distributional national accounts that combined income measures from tax and survey data with figures published in the national accounts. In this way, they examined pre-tax and post-tax income inequality in the United States for the years 1913 to 2014 and documented a massive increase in both types of inequality since 1980.

Proportional allocation of government expenditure overstates inequality

“The fact that inequality in income distribution has increased in the US is beyond doubt. However, the results of Piketty’s study on the extent of after-tax inequality depend very much on the authors’ assumptions about the distribution of government spending. Against this background, it becomes clear that Piketty et al. overestimate the level of inequality (post-tax, post-transfer) with their method,” says Professor Holger Stichnoth, head of ZEW’s Research Group “Inequality and Public Policy”. After all, in order to calculate how evenly a country distributes its expenditures among its inhabitants, all government expenditures must be allocated to individuals, i.e. also non-cash benefits such as public expenditures for education, infrastructure and defence. In their study, Piketty and his co-authors assume that these in-kind expenditures are allocated to individual US residents in proportion to their respective cash transfers. “Based on this assumption, the poorest 50 per cent receive on average only 4,000 US dollars per year in public in-kind benefits, while the richest of the rich – who are much less likely to take the bus or send their children to public schools – receive several million,” Stichnoth criticises.

Lump-sum approach is more realistic

The ZEW study by Holger Stichnoth and his colleague Lukas Riedel, on the other hand, suggests that a lump-sum allocation in which everyone receives the same amount of in-kind transfers is more realistic. “If expenditures are lumped together, for 2014 in the US, the gap in post-tax income shares between the highest-income 10 per cent and the lowest-income 50 per cent of citizens is reduced by half compared to the Piketty study,” Stichnoth says. Even with this method, the inequality of the US income distribution has increased – but at a lower level. The ZEW study is based on data from the American Community Survey 2017 and the Education at a Glance reports published by the Organisation for Economic Co-operation and Development (OECD).

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