There is no denying the fact that the top 1 percent of the income distribution in the United States (US) has done very well for itself in the last four decades. The corresponding fact that the bottom 20 percent has not done remotely as well as the top 1 percent grates on a lot of Americans.
Egalitarian-minded Americans standardly look at Europe and many wish that we would import some of Europe’s best practices so that income inequality in the US is not as high as it is today. This raises the question of what “best practices” we ought to import so as to make us in the US, at least along the income equality dimension, more like them in Europe.
Given our history and our ethos, very few of us want to import a Scandinavian system with (relatively speaking) very high levels of taxes. That said, it is fair to say that many Americans believe that Europe, in general, uses taxes and transfers to redistribute a lot more of its income to those less well-off and this is one of the key reasons why Europe is more egalitarian than the US. Even research put out by the Organization for Economic Cooperation and Development (OECD)—a rich country club—suggests that this belief is true.
Since there is so much debate among politicians and citizens about the appropriate use of taxation, it is worth examining whether the above belief is true. Up until now, because of a variety of differences in the ways in which data have been collected and particularly the use of surveys that underrepresent top incomes, it has been impossible to meaningfully study whether the above belief is true.
Very recently, Thomas Blanchett, Lucas Chancel, and Amory Gethin have undertaken painstaking empirical work and have shed valuable light on the veracity of the belief mentioned above. They point out clearly that between 1980 and 2017, income inequality has gone up in both Europe and in the US but it has gone up by less in Europe. In this time period, the share of pre-tax income accruing to the richest 1 percent in Europe rose from 8 percent to 11 percent before taxes and transfers and from 7 percent to 9 percent after taxes and transfers. In the US, the top 1 percent’s share of pre-tax income increased from 11 to 21 percent and its post taxes and transfers income rose from 9 to 16 percent.
The key question now is this: Can the fact that income inequality rose by less in Europe be explained by Europe’s supposedly more redistributive tax system? The surprising answer provided by Professor Blanchett and his colleagues is “No.” What these researchers show is that the distribution of taxes and transfers does not explain the sizeable gap in the level of income inequality between Europe and the US. In fact, once one accounts for all taxes and transfers, the empirical evidence suggests that the US redistributes a greater proportion of its national income to the poorest 50 percent of the population than any European nation.
In the words of these researchers, it is “predistribution” and not “redistribution” that explains why Europe is more egalitarian than the US when it comes to the metric of income inequality. What this really means is that compared to the US, Europe has been a lot more successful in ensuring that its low-income groups benefit from relatively well-paying jobs.
In sum, the post-tax distribution of income in Europe is more egalitarian than the corresponding distribution in the US but this is not because of the reason offered by many Americans. As a matter of general principle, taxes and transfers matter but in this case, they appear to play little or no role in determining the post-tax income inequality that we actually observe on either side of the Atlantic Ocean.
Batabyal is the Arthur J. Gosnell professor of economics and the Interim Head of the Sustainability Department, both at RIT, but these views are his own."