- Front Page
- Municipal Affairs
- Bon Voyage
May 9, 2012
Editor’s Note: On May 1, Troy Media ran a commentary by Jason Clemens, Director of Research for the Macdonald-Laurier Institute, called Income Inequality: Oversimplifying a complicated issue, based on his report of the same name. We’ve decided to run his entire report as a backgrounder to this important issue.
OTTAWA, ON, May. 9, 2012/ Troy Media/ – The Occupy Wall Street (OWS) movement, coupled with increasing unease over high unemployment and slow economic growth, has placed the perennial issue of income inequality front and centre once again. These concerns were further stoked by a major report by the Organization for Economic Cooperation and Development (OECD) in late 2011.
There are certainly reasons to be concerned about the distribution of income across society. However, all too often this issue is oversimplified with responsive solutions demanded and sometimes implemented, which often worsen rather than improve the observed problems.
This series is dedicated to summarizing many of the complicating factors that need to be considered when discussing and debating income inequality and the potential solutions available.
Some of these factors are easily understood and thus presented concisely. Other factors, such as mobility, require a more developed presentation in order to fully understand their implications for understanding inequality.
Where applicable, a discussion of how these complexities manifest themselves in an international context is also presented. The discussion of international considerations is important given that so much of the analysis on inequality is presented within an international context.
Although not exhaustive, the study has included discussions of the following factors connected with understanding inequality in Canada and internationally.
Pre-tax versus after-tax income
One simple dimension of inequality statistics that is sometimes ignored is the selection of pre-tax versus after-tax measures of income, which includes government transfers.
Pre-tax measures of income make little sense given that so many mechanisms exist within the tax system to both lighten the tax burden and in many cases transfer income to lower-income households.
The Working Income Tax Benefit (WITB), for example, reduces the tax burden for workers by providing a tax credit against taxes owed. However, it also acts as a direct transfer of income to lower-income households. The Working Income Tax Benefit transfers income to some households through its refundability.
For households where the value of the tax credit exceeds the tax liability (taxes owed), a direct cash payment to the household is made for the difference. Thus, for lower-income households this type of tax credit becomes a direct cash transfer.
In other cases, such as the Goods and Services Tax (GST) credit, there is a direct quarterly payment to eligible households. These tax credits as well as other mechanisms serve to transfer income to lower-income households.
Thus, to accurately ascertain inequality in income, measurements should focus on after-tax income including government transfers rather than pre-tax income in order to include the effects of these mechanisms.
Figure 1 illustrates a measure of the income of the top 10 per cent (decile) compared to the lowest 10 per cent as a ratio for both pre-tax and after-tax income (including transfers).
The implication of comparing the two measures is that after-tax income results in a lower rate of inequality. For example, in 2008, the most recent year for which data is available, pre-tax income indicated inequality between the bottom and top 10 per cent as 18.0.
In other words, the top 10 per cent earned 18.0 times what the bottom ten per cent earned. This ratio drops to 13.8, a reduction of 30 per cent when after-tax income is used rather than pre-tax.
This should not be surprising given the nature of the tax transfers discussed, which can both reduce the tax burden for lower-income families and, more importantly, act as a direct cash transfer. The implication of this insight is that any measure of income inequality that relies on pre-tax income is more than likely over-estimating income inequality by ignoring the effects of these income transfer mechanisms.
Next: Limitations with inequality data