Why Is Europe More Equal Than The United States

Thomas Blanchet, Lucas Chancel and Amory Gethin, "Why Is Europe More Equal Than The United States,"Paris School Of Economics, November 9, 2021, https://wid.world/document/why-is-europe-more-equal-than-the-united-states-world-inequality-lab-wp-2020-19/

“…Why do our conclusions contradict the standard view on redistribution in Europe and the US? We find that this is the case for three main reasons. First, OECD estimates rely exclusively on surveys, while we systematically distribute the entire national income by combining surveys with tax data and national accounts. Second, standard estimates of redistribution only allocate direct taxes and transfers to individuals, thereby ignoring corporate taxes, indirect taxes, and in-kind transfers. Distributing these components of government revenue and expenditure reverts the rankings of Europe and the US in terms of redistribution. This is because indirect taxes are much higher in Europe than in the US and fall disproportionately on low-income earners. Third, our benchmark measure of redistribution compares pretax incomes to Post tax incomes, while the standard view tends to compare factor incomes (sometimes referred to as market incomes) to posttax incomes. Because many European countries have a greater share of pensioners than the United States, and because public pension systems are much more developed in Europe than in the US, including pensions in the analysis leads to increasing estimates of redistribution more in the former than in the latter. However, as we now show, our conclusions are strongly robust to using one or the other of these two income concepts….”

Predistribution vs. Redistribution: Revisiting the Europe-US inequality gap

“…Figure VIIa directly answers this question by representing the share of national income transferred by the tax-and-transfer system between pretax income groups in Eastern Europe, Western and Northern Europe, and the United States in 2017. The bottom 50% and the middle 40% are net beneficiaries of redistribution in all three regions, but the US tax-and-transfer system appears to be unequivocally more progressive. The bottom 50% in the US received a positive net transfer of 6% of national income in 2017, compared to about 4% inWestern and Northern Europe and less than 3% in Eastern Europe. Meanwhile, the top 10% saw their average income decrease by 8% of national income in the US after taxes and transfers, compared to about 4% in Western and Northern Europe and 3% in Eastern Europe. The middle 40% benefits slightly more from redistribution in the US (2%) than in Europe (less than 1%)….”

The Net Impact of Taxes and Transfers on Inequality

“…FigureVIbprovides a complementary picture of the magnitude and progressivity of government expenditure by plotting total transfers received by the bottom 50% in European countries and the United States, expressed as a share of national income. The US ranks third in terms of the smallest share of national income transferred to the bottom 50% (about 13%), due mainly to lower expenditure on pensions. In Europe, transfers received by the poorest half of the population are smallest in Serbia (11%), followed by Romania (12%), Estonia (14%), and Poland (14%). Meanwhile, Denmark, the Czech Republic, Sweden, the Netherlands, Belgium, and Finland stand out as the European countries allocating the greatest share of national income to the poorest half of the population (22-23%, corresponding to slightly less than half of all government revenue in these countries)….”

“…As for taxes, total government expenditure is significantly lower in the US (35% of national income) than in Europe (47%).36 The difference between the two regions is due to cash transfers, which represent 9% of national income in the US compared to 23% in Europe. Within cash transfers, pensions are the aggregate that differs the most between the two regions (16% of national income in Europe versus 5% in the US), followed by family and social assistance transfers (5% vs. 3%) and unemployment and disability benefits (1.6% vs. 1.4%). Meanwhile, in-kind transfers in health, education, and other collective government expenditure are very similar in Europe and the US (25-26%, of which about 7% goes to health). Total government expenditure is higher in Northern Europe (51% of national income) and Western Europe (48%) than in Eastern Europe (42%), due mainly to the larger size of social assistance transfers (5% inWestern and Northern Europe vs. 3.5% in Eastern Europe) and in-kind transfers (29% vs. 25% vs. 23%, respectively) in Western and Northern Europe. Figure VIa presents the distribution of transfers across posttax income groups in Europe and the US, expressed as a share of posttax national income. Unsurprisingly, transfers are progressive in both the US and Europe: they represent over 60% of the posttax incomes of bottom deciles, compared to less than 30% of those of the top 1%. Pensions represent a smaller share of posttax income in the US than in Europe for all posttax income groups, while the distribution of other cash transfers is relatively similar between the two regions. Health payments are the most progressive type of transfers. In Europe, this is directly due to the fact that we distribute health expenditure on a lump-sum basis, assuming as a first approximation that all individuals benefit from the same in-kind transfer (see methodology). Health expenditure is also highly progressive in the United States, where public health spending is significant and targeted towards the very poor (via Medicaid). Other in-kind transfers are neither progressive nor regressive, because we assume that they are distributed proportionally to posttax disposable income (we come back to this assumption in the next section)…”

The Structure and Distribution of Transfers

“…By doing so and by narrowing down the analysis to the employed and working-age (20-64) population, the analysis remains consistent and cross-country comparisons meaningful. The main conclusions are unchanged. Because social contributions fall on labor income and are generally set at fixed rates, they tend to be flat for most groups within the bottom 90% and regressive at the top. This turns the tax systems of Western and Northern European countries into approximately flat tax systems, while those of most Eastern European countries become strongly regressive at the top end of the distribution. Because social contributions are smaller in the United States than in Europe, the US tax system remains more progressive than that of all European countries (with the exception of the UK)….”

“…Figure Vb ranks European countries and the United States according to a simple measure of tax progressivity: the ratio of the total tax rate faced by the top 10% to that of the bottom 50%. The composition of bars correspond to the composition of taxes paid by the top 10%. The US stands out as the country with the highest level of tax progressivity: the top decile faces a tax rate that is more than 70% higher than that of the poorest half of the population. By this measure, the European country with the most progressive tax system is the United Kingdom, followed by Norway, the Czech Republic, and France. Many European countries have values close to 1 on this indicator, corresponding to relatively flat tax systems, in which top income groups face a tax rate approximately equal to that of the bottom 50%....”

“..Figure Va represents the level and composition of non-contributory taxes paid by pretax income group in Eastern Europe, Western and Northern Europe, and the United States in the past decade.34 Two results clearly stand out. First, while taxes paid are lower in the US than in Europe for most pretax income groups, the taxation profile is unambiguously more progressive in the United States. The top 1% face a tax rate higher than 30% in the US, which is relatively comparable to what we observe in Western and Northern Europe. Meanwhile, bottom income groups are taxed an average rate that is nearly twice as small in the US as in Europe. Second, the difference in tax progressivity between the two regions is mainly driven by indirect taxes, which represent a significantly larger share of national income in Europe than in the US. These taxes tend to be regressive, because they are paid proportionally to consumption…”

“…Before investigating the distributional impact of taxes, it is useful to briefly compare the size and composition of government revenue in Europe and the United States.33 In 2007-2017, taxes and social contributions amounted to 47% of national income in Europe, compared to 28% in the United States. The United States collected less tax revenue than any European country, from Romania (32%), the country with lowest tax revenue, to Denmark (57%), which displayed the highest tax to national income ratio. The gap between the two regions was driven by two components of revenue: social contributions, which represented 19% of national income in Europe versus 8% in the US, and indirect taxes (14% versus 7%). Meanwhile, both regions collected comparable amounts of revenue from income and wealth taxes (10-11%) and from corporate income taxes (3%). The macroeconomic tax rate was larger in Northern Europe (52%) than in Western Europe (48%) and Eastern Europe (41%), due mostly to the larger share of national income collected in income and corporate taxes. If one excludes contributory social contributions from the analysis (that is, contributions financing the pension and unemployment systems), then the gap between Europe and the US decreases but remains significant: 23% of national income was collected in non-contributory taxes in the US in 2007-2017, compared to 30% in Europe….”

The Structure and Distribution of Taxes

“…TableIVprovides a more detailed picture of the rise of pretax income inequality by showing the real average annual income growth of selected income groups in our four regions of interest over the 1980-2017 and 2007-2017 periods.30 National incomes grew at a modest yearly rate in the past four decades in Europe and the US: 1% in Western Europe, 1.2% in Eastern Europe, 1.4% in the US, and 1.8% in Northern Europe. In all regions, however, growth rates have been markedly higher the further one moves towards the top end of the distribution. The average pretax income of the top 1% thus rose at a rate of 1.9% in Western Europe, 3.2% in Northern Europe, 3.3% in the US, and 3.8% in Eastern Europe. Meanwhile, middle-income groups saw their average pretax incomes grow at a rate closer to the average of the full population in all regions. The bottom 20% benefited the least from real national income growth: their average income increased at a rate of 1.2% in Northern Europe and 0.7% in Western Europe, while it decreased at a rate of 1.3% in Eastern Europe and fell on average by 1.1% every year in the United States….”

“..The US ranks third of all the countries considered here, with an increase in the top 10% share of almost 14 percentage points. In Western Europe, Germany is the country where the top 10% share grew the most (+ 9 percentage points)…”

“…We now turn to documenting the evolution of pretax income inequality in Europe and the US. FigureIIashows the evolution of the top 10% pretax income share in the US, Eastern Europe, Western Europe, and Northern Europe from 1980 to 2017. The United States remained more unequal than most European countries throughout the entire period, but the gap between Europe and the US has widened significantly over time.27Indeed, the top 10% rose most rapidly and steadily in the US (from 34% to 48%), followed by Eastern Europe (from 24% to 36%), Western Europe (from 30% to 35%), and Northern Europe (from 26% to 31%). From 1980 to 2017, Eastern Europe shifted from being the least unequal to the most unequal European region. A significant part of this change occurred between 1989 and 1995, following thedisintegration of the Soviet Union and the transition of Eastern European countrie to market economies…”

The Distribution of Pretax Income Growth

“…How do pretax incomes vary in Europe and the United States today? Table III provides a first answer to this question by displaying the average incomes and income shares of key income groups in Western Europe, Northern Europe, Eastern Europe, and the US in 2017. The average national income per adult stood at e52,700 in the US at purchasing power parity, compared to e44,900 in Northern Europe, e35,300 in Western Europe, and e21,700 in Eastern Europe. In Europe, only Norway (e55,000) and Luxembourg (e102,000) have higher average national incomes than the US.23Things look very different at the bottom of the pretax income distribution. Thebottom 50% earned only about e12,300 in the US in 2017, compared to e21,600 inNorthern Europe and e14,600 in Western Europe. Of the twenty-seven countriesconsidered in this paper, the US thus ranks third in terms of average national incomeper adult but nineteenth when it comes to the average income of the poorest 50%.24On average, pretax income inequality at the bottom is lowest in Northern Europe(with a bottom 50% share of 24%), followed by Western Europe (21%) and EasternEurope (20%). With a bottom 50% pretax income share of only 11.7%, the US is byfar the most unequal of all countries, followed by a distant Serbia (16%) and veryfar from the values observed in the Czech Republic, Iceland, Norway, and Sweden(all above 25%).25These differences appeared even more pronounced at the verybottom of the distribution: the average income of the poorest 20% was e11,600 inNorthern Europe in 2017, more than three times larger than its counterpart in theUnited States (e3,800).The same differences are visible at the top end of the distribution: the top 1% captured 21% of total pretax income in the US in 2017, compared to 12% in Eastern Europe, 11% in Western Europe, and less than 9% in Northern Europe. In 2017, the top 0.001% average pretax income exceeded e92 million in the US, nearly ten times the value observed in Northern Europe. The European countries with lowest top 1% income shares are the Netherlands, Slovenia, Iceland, Belgium, and Finland (less than 9%), while those with highest top income concentration are Germany, the United Kingdom, Greece, and Poland (13-15%).26 In summary, while the US stands out as being richer than most European countries today, differences in average national incomes mask substantial heterogeneity. With inequality levels surpassing by far those observed in any European country, theUS displays bottom pretax average incomes that barely exceed those observed inpoorer Eastern European countries. In contrast, the lower inequality levels and higheraverage incomes observed in Northern Europe imply significantly better standardsof living for the majority of the population than in the United States….”

“..The efforts made by the Luxembourg Income Study (LIS) to harmonize existing surveys, for instance, have been extremely helpful to improve the comparability of pre-2000 inequality statistics in Europe. Yet, because of sampling issues and misreporting at the top of the income distribution, surveys can picture evolutions that are inconsistent with those suggested by tax data. In this paper, we combine for the first time all these sources in a meaningful way, using new techniques and a consistent methodology. We show that correcting for the weaknesses of existing estimates does lead to substantively different conclusions on the level and evolution of inequality in Europe, the distributive impact of taxes and transfers, and how inequality and redistribution compare across European countries….”

Core Evidence

“..the main reason for Europe’s relative resistance to the rise of inequality has little to do with the direct impact of taxes and transfers. While Western and Northern European countries redistribute a larger fraction of output than the US (about 47% of national income is taxed and redistributed in Europe versus 35% in the US), the distribution of taxes and transfers does not explain the large gap between Europe and US posttax inequality levels. Quite the contrary: after accounting for all taxes and transfers, the US appears to redistribute a greater fraction of its national income to the poorest 50% than any European country. This finding stands in sharp contrast with the widespread view that “redistribution”, not “predistribution”, explains why Europe is less unequal than the US (e.g.,OECD, 2008;2011). In other words, Europe has been much more successful than the US at ensuring that its low-income groups benefit from relatively good-paying jobs. We show that the differences between our conclusions and those of the OECD are driven by several factors, including the greater underrepresentation of top incomes in US surveys, the fact that we account for indirect taxes and in-kind transfers, which are moreprogressive in the US than in Europe overall, and the inclusion of pensions in the definition of pretax income….”

“…Between 1980 and 2017, the share of pretax income that accrued to the richest 1% Europeans rose from 8% to 11% before taxes and transfers and from 7% to 9% after taxes and transfers. In the US, the top 1% pretax income share rose from 11% to 21% over the same period, and the top 1% post tax income share from 9% to 16%....”

Steve Notes

The bottom 20% in the US earn effectively zero, suggesting they don’t have jobs vs Northern Europe,which earns 21.6 euros suggesting they have significant jobs. That seems like apples to oranges. The amount transferred to the bottom 20% in the US seems very small compared to the amount calculated in the table we made of the many experts estimating the amounts. 6k euros vs tens of thousands of dollars. Lastly, they mix retirees with the poor so straightforward comparisons are very complicated/impossible. Perhaps they break them out in the online data table.

And also

3.2 delta/36.6 (average national income per capita) = 8.7% vs the chart above, which says 4.4%. I did this for the other (three) countries and found the same result: the allocation in the table seemed to be twice the number in the chart. I only have the chart for the US and not the table. So I believe I have to double the number in the chart to produce an equivalent table. But that’s too bold a leap for me to use publicly. Perhaps I don’t understand the chart or my math is wrong. I interpret the chart to be: what percent of national income is being distributed to the bottom 50% on net (i.e. less taxes plus services). On net, the US distributes more to the poor than other countries and national income per capita is larger so dollar-wise (or euro-wise in this case) more gets distributed both percentage-wise and even more so dollar-wise. Several other things made my ears perks up: Not presenting a comparable US page is a red flag. They use Piketty and Saez data for the US. But those estimates were criticized by Auten and Splinter. Pages 67 and 68 in the appendix show the (supposedly real) growth in average income (both are inflated to 2017ppp adjusted euros). But what inflation index did they use for the US and Europe, and are those indexes similarly accurate? When you inflate/deflate over that long a time period, the indexes matter. I’m always leery of data that changes significantly in a couple years. The significant down tick in the US and uptick in Europe makes my ears perk up. Things seldom change quickly. And, as far as I know, the incomes of American lesser-skilled workers grew faster than the economy on average (so their share would be growing).

Taking France as an example. It says the difference between pre and post tax income for the bottom 50% is 4.4% of national income. 21.0 (post tax per capita income for the bottom 50%, measured in 2017 purchasing poser adjusted euros) - 17.8 (pretax income for the bottom 50%) = 3.2 delta between pre and post

They have a chart like this for each country which show the net effect (i.e., minus taxes plus services)

And also

Blanchet Comment, “The figure for net redistribution shows the aggregate amount of income that is redistributed (on net) to each group, while you are calculating the change in each group’s average income. That is where the factor 2 comes from. The bottom 50% receives 4.4% on national income on net, but since that is distributed across half of the population, the change in that group’s average is twice as large. We don't show the US in our appendix because for them we are not making our own estimates, but use the data from:https://gabriel-zucman.eu/usdina/We always use the GDP implicit price deflators as price indexes, which in principle are harmonized across countries to the same extent that GDP numbers are.”