frank cowell: economics public economics msc public economics 2010/11 wealth taxation 31 january
TRANSCRIPT
Frank C
owell:
Frank C
owell: E
conomics
Econom
ics Public E
conomics
Public E
conomics
MSc Public Economics 2010/11
http://darp.lse.ac.uk/ec426
Wealth TaxationWealth Taxation
31 January 2010
.
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Overview...Wealth taxation
Wealth distribution
Wealth trends
Long-run models
Wealth Distribution and Taxation
Why wealth taxation? Types of tax
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Why wealth taxation?
Revenue raising?Revenue raising? Estate, inheritance and gift taxes as percent of total tax revenueEstate, inheritance and gift taxes as percent of total tax revenue Cremer and Pestieau (2003) from OECD Revenue Statistics (2000)Cremer and Pestieau (2003) from OECD Revenue Statistics (2000)
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Efficiency and equity considerations
Efficiency case for or against wealth taxes is unclearEfficiency case for or against wealth taxes is unclear ((Cremer and Cremer and PestieauPestieau 2003 2003))
Equity case for wealth taxes is more promisingEquity case for wealth taxes is more promising But needs careful empirical analysisBut needs careful empirical analysis Who owns what?Who owns what?
Direct impact of wealth taxes on redistribution likely to be smallDirect impact of wealth taxes on redistribution likely to be small small revenue raised…small revenue raised… ……less than 1% of receipts?less than 1% of receipts? not much taken from rich to give to poornot much taken from rich to give to poor
But what of long run? But what of long run? taxes may influence savings behaviour and bequest behaviourtaxes may influence savings behaviour and bequest behaviour these influence wealth accumulation and inequalitythese influence wealth accumulation and inequality
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Forms of wealth taxation
Annual wealth tax:Annual wealth tax: mostly on an overall measure of net worthmostly on an overall measure of net worth some specific wealth taxes (property taxes)some specific wealth taxes (property taxes)
Inheritance tax: Inheritance tax: taxes taxes transfertransfer of wealth at death of wealth at death taxes the beneficiaries of the estatetaxes the beneficiaries of the estate
Estate tax:Estate tax: taxes taxes transfertransfer of wealth at death of wealth at death taxes the personal representatives of the deceasedtaxes the personal representatives of the deceased also known as estate duty / death dutyalso known as estate duty / death duty
Transfer taxTransfer tax taxes taxes transfertransfer of wealth not necessarily at death of wealth not necessarily at death
Some jurisdictions without wealth taxation Some jurisdictions without wealth taxation
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Overview...Wealth taxation
Wealth distribution
Wealth trends
Long-run models
Wealth Distribution and Taxation
Definitions, composition and inequality
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Wealth concepts in the UK
British Household Panel SurveyBritish Household Panel Survey fairly comprehensivefairly comprehensive suffers from standard participation / attrition problemssuffers from standard participation / attrition problems
Wealth and assets surveyWealth and assets survey uses survey and administrative data – comprehensiveuses survey and administrative data – comprehensive newly emerged, so no time-series analysisnewly emerged, so no time-series analysis
HMRC Identified personal wealthHMRC Identified personal wealth emerges directly from the estate multiplier methodemerges directly from the estate multiplier method it is clearly biased (missing wealth, missing persons)it is clearly biased (missing wealth, missing persons) differs from balance-sheet concept of wealthdiffers from balance-sheet concept of wealth
HMRC Series C: marketable wealth onlyHMRC Series C: marketable wealth only valuation issues addressedvaluation issues addressed excluded population correctedexcluded population corrected
HMRC Series D: includes a valuation of pension rightsHMRC Series D: includes a valuation of pension rights HMRC Series E: includes a valuation of state pension rightsHMRC Series E: includes a valuation of state pension rights
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HMRC “Identified wealth” 2003
Residential buildings about 50% of net worth, except for £500,000+
Debts concentrated amongst those with less than £100,000
Securities concentrated amongst the rich
net
capi
tal v
alue
of
esta
te
Secu
riti
es
Cas
h
Loa
ns, m
ortg
ages
et
c
Pol
icie
s of
in
sura
nce
Res
iden
tial
bu
ildin
gs
Oth
er B
uild
ings
an
d L
and
Oth
er a
sset
s
Net
as
% g
ross
Mor
tgag
es
Oth
er d
ebts
0 - £50,000 4.6% 22.7% 5.6% 8.9% 47.6% 0.1% 10.5% 61.0% 5.7% 33.4%
£50000 - £100,000 4.5% 16.2% 3.0% 14.6% 55.0% 0.0% 6.8% 83.3% 4.1% 12.6%
£100000 - £150,000 3.9% 14.0% 2.4% 18.6% 55.2% 0.1% 5.8% 84.4% 4.3% 11.3%
£150000 - £200,000 4.5% 14.4% 0.7% 12.1% 59.4% 1.6% 7.5% 89.0% 4.9% 6.1%
£200000 - £500,000 8.5% 12.8% 0.9% 12.6% 54.7% 1.5% 9.0% 89.7% 6.5% 3.8%
£500000 - £1000,000 17.6% 11.2% 1.6% 7.6% 42.5% 5.3% 14.1% 93.8% 3.9% 2.3%
£1,000,000 and over 23.8% 10.8% 1.9% 5.0% 28.1% 8.1% 22.4% 94.2% 2.9% 3.0%
Source: HMRC statistics table 13.2Source: HMRC statistics table 13.2
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Proportion of wealth in securities. UK 2003
0%
5%
10%
15%
20%
25%
30%
35%age 18-44
age 45-64
aged 65 and over
All ages
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Proportion of wealth in residential buildings. UK 1999
0%
10%
20%
30%
40%
50%
60%age 18-44
age 45-64
aged 65 and over
All ages
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Proportion of wealth in residential buildings. UK 2003
0%
10%
20%
30%
40%
50%
60%
70%
0 - £50,000 £50,000 - £100,000 - £150,000 - £200,000 - £500,000 - £1,000,000 -
age 18-44
age 45-64
aged 65 and over
All ages
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Wealth distribution by age
1999. Quantile points of top...
£0
£200,000
£400,000
£600,000
£800,000
£1,000,000
£1,200,000
age 18-44
age 45-64
aged 65 and over
40%
30%
20%
10%
5%
1%
2003. Quantile points of top...
£0
£200,000
£400,000
£600,000
£800,000
£1,000,000
£1,200,000
age 18-44
age 45-64
aged 65 and over
40%
30%
20%
10%
5%
1%
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Identified Wealth UK 1999
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0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
Proportion of population
Pro
por
tion
of
wea
lth
Identified Wealth Gini=0.58
Series C Gini=0.67
Series D Gini=0.59
Series E Gini=0.49
UK wealth, 1994: Lorenz
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UK: BHPS (LWS) and HMRC
-0.20
0.00
0.20
0.40
0.60
0.80
1.00
0.00 0.20 0.40 0.60 0.80 1.00
UK BHPS 2000 NW1
UK HMRC 2000 Series C
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UK: WAS 2009
-0.1
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
Total Wealth Percentiles
Financial Physical WealthPercentiles
Financial Physical PropertyWealth Percentiles
Equality
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Household portfolio composition – LWS
Wealth components Canada Finland Germany Italy Sweden
United
Kingdom
US
PSID
US
SCF
1999 1998 2002 2002 2002 2000 2001 2001
Non-financial assets 78 84 87 85 72 83 67 62
Principal residence 64 64 64 68 61 74 52 45
Real estates 13 20 23 17 11 9 14 17
Financial assets 22 16 13 15 28 17 33 38
Deposit accounts 9 10 n.a. 8 11 9 10 10
Bonds 1 0 n.a. 3 2 n.a. n.a. 4
Stocks 7 6 n.a. 1 6 n.a. 23 15
Mutual funds 5 1 n.a. 3 9 n.a. n.a. 9
Total assets 100 100 100 100 100 100 100 100
Total debt 26 16 18 4 35 21 22 21
Home secured 22 11 15 2 n.a. 18 n.a. 18
Total net worth 74 84 82 96 65 79 78 79
Source: Sierminska et al (2006); see also Source: Sierminska et al (2006); see also Davies et al (2010) Davies et al (2010)
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LWS series ordered by Ginic of v Gini
ITALY 2004 NW1 1.387 0.565
ITALY 2002 NW1 1.477 0.573
FINLAND 1998 NW1 1.453 0.588
CYPRUS 2002 NW1 3.993 0.635
FINLAND 1994 NW1 1.419 0.648
UK BHPS 2000 NW1 1.705 0.689
CANADA 1999 NW1 2.396 0.755
GERMANY 2002 NW1 2.550 0.758
SWEDEN 2002 NW1 5.969 0.849
US SCF 2001 NW1 5.062 0.911
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LWS: Net worth
-0.1
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
Canada 1999 NW1
US SCF 2000 NW1
UK 2000 NW1
Sweden 2002 NW1
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LWS: Net worth (top 10%)
-0.1
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
Canada 1999 NW1
US SCF 2000 NW1
UK 2000 NW1
Sweden 2002 NW1
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Measurement tool for wealth distributions Choose an arbitrary base level wealth Choose an arbitrary base level wealth bb Calculate a conditional mean and normalise:Calculate a conditional mean and normalise:
““average” average” E E ((x | xx | x bb)) “ “base”base” b b
Advantages:Advantages: easy interpretationeasy interpretation focuses on upper tailfocuses on upper tail
Disadvantage: Disadvantage: depends not only on distribution but also on the arbitrary depends not only on distribution but also on the arbitrary bb
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Functional form for wealth distribution
0 1 2 3 4 5
f(x)
= 1.5
= 2.0
The Pareto Distribution
FF((xx) = 1 ) = 1 −− [ [ xx / / xx ] ]
ff((xx))xxxx captures “weight” of the tailcaptures “weight” of the tail xx “locates” the distribution “locates” the distribution average average = = base base −− 1 1
11GiniGini = = 22 −− 1 1
Higher (less inequality)
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-7
-6
-5
-4
-3
-2
-1
08 9 10 11 12 13 14 15
log Wealth
log(
1−F
)
Pareto diagram: application
UK: Identified Personal Wealth 2003Inland Revenue Statistics 2006 Table 13.1
log (1−F) = −1.7618 log W + 19.761
Plot log wealth against log( 1 – F)
Data points
Top 7 points
Fit straight line
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Overview...Wealth taxation
Wealth distribution
Wealth trends
Long-run models
Wealth Distribution and Taxation
Rising inequality or stability?
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Trends in wealth inequality Useful to look at Useful to look at trendstrends in distribution in distribution
what effect of wealth taxation in the past?what effect of wealth taxation in the past? equalisation?equalisation? is there a trend toward stability…?is there a trend toward stability…? …….or divergence?.or divergence?
For historical and recent wealth trends in USFor historical and recent wealth trends in US KopczukKopczuk and and SaezSaez, (2004), (2004) Substantial time coverage: Substantial time coverage: From early 20From early 20thth century century
For historical wealth trends in UKFor historical wealth trends in UK Atkinson et al. (1989)Atkinson et al. (1989) Similar time coverage…Similar time coverage… But incomplete seriesBut incomplete series
Recent picture from Inland Revenue dataRecent picture from Inland Revenue data
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Distribution of wealth US 1916-2000
Wealth owned by various groups
05
1015202530354045
1915
1925
1935
1945
1955
1965
1975
1985
1995
2005
perc
ent
top 2%
top 1%
top 0.5%
top 0.25%
top 0.1%
top 0.05%
top 0.01%
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Distribution of marketable wealth UK 1976-2002 (Series C)
Wealth owned by various groups
0102030405060708090
100
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
perc
ent
top 50%
top 25%
top 10%
top 5%
top 2%
top 1%
Gini Coefficient
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Pareto’s : USA and UK
1.2
1.4
1.6
1.8
2
2.2
2.4
2.6
2.8
3
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
2000
US income
UK income
US wealth
England & Wales wealth
UK wealth (1)
UK wealth (2)
• Sources: see Cowell (2010) Chapter 4 Sources: see Cowell (2010) Chapter 4
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Wealth trends
US and UK: Substantial wealth inequalityUS and UK: Substantial wealth inequality UK Inequality falls in early 20UK Inequality falls in early 20thth century century
roughly from first world warroughly from first world war substantive rises in income tax and estate dutysubstantive rises in income tax and estate duty
Reductions in inequality continue through mid-centuryReductions in inequality continue through mid-century US inequality falls from time of great depressionUS inequality falls from time of great depression
Largely attributable to stock pricesLargely attributable to stock prices Large concentration of corporate stock in wealth of very richLarge concentration of corporate stock in wealth of very rich
But US inequality also carried on falling through to 70sBut US inequality also carried on falling through to 70s This despite recovery in stock pricesThis despite recovery in stock prices Antitrust legislation?Antitrust legislation? Development of estate taxDevelopment of estate tax
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Overview...Wealth taxation
Wealth distribution
Wealth trends
Long-run models
Wealth Distribution and Taxation
Fairy tales?
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A way forward Direct impact of wealth taxes on redistribution will be smallDirect impact of wealth taxes on redistribution will be small But wealth taxes may work by influencing long-run distributionBut wealth taxes may work by influencing long-run distribution
requires careful modellingrequires careful modelling small taxes can have powerful effects on the equilibrium (Kaplow 2000)small taxes can have powerful effects on the equilibrium (Kaplow 2000)
Develop a story of wealth distribution in the long run (Develop a story of wealth distribution in the long run (Piketty 2000Piketty 2000):): Characterise each generation as a fixed time unitCharacterise each generation as a fixed time unit Specify financial constraintsSpecify financial constraints Model preferences / tastes / habitsModel preferences / tastes / habits Model exogenous resource flowModel exogenous resource flow Specify family formation mechanismSpecify family formation mechanism
Preferences: what motivates bequests? (Preferences: what motivates bequests? (Kopczuk 2010Kopczuk 2010)) AltruismAltruism ExchangeExchange Warm-glowWarm-glow Accident and inertiaAccident and inertia
Examine three illustrative modelsExamine three illustrative models
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Outline of model (1)
Common practice to combine in a neoclassical modelCommon practice to combine in a neoclassical model ((Becker and Tomes 1979))
Preferences and behaviourPreferences and behaviour Cobb-Douglas preferences (simplified savings behaviour)Cobb-Douglas preferences (simplified savings behaviour) utility maximisation by parental generationutility maximisation by parental generation look one generation aheadlook one generation ahead
Simplified family characteristicsSimplified family characteristics exogenous attributesexogenous attributes no “marriage story”no “marriage story” no “fertility story”no “fertility story”
Resources and marketsResources and markets ““perfect” marketsperfect” markets exogenous (labour) earnings and initial endowmentsexogenous (labour) earnings and initial endowments
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CCn n + + BBnn /[1+ /[1+rrnn] ] WWnn
½½k Wk Wnn+1+1 = = ss[1+[1+rrnn] ] WWnn ++ s E s Enn+1+1
WWnn ++ E Enn+1+1 /[1+ /[1+rrnn] ]
WWnn+1+1 = = [1+[1+rrnn] ] WWnn ++ E Enn+1+1
½½k Wk Wnn+1+1 = = BBnn
Illustrative model (1) Generational budget constraint Wealth accumulation equation Prospective resources Proportionate savings rate s Equation for wealth accumulation
Stochastic “earnings” will give a simple Markov chain.Stochastic “earnings” will give a simple Markov chain. given sensible parameter values will get convergence (regression to mean)given sensible parameter values will get convergence (regression to mean) Initial wealth inequalities will be damped awayInitial wealth inequalities will be damped away
In the long run wealth inequality is going to be determined just by In the long run wealth inequality is going to be determined just by EE..
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Simulation approach
It is common to put some variant of is this into a It is common to put some variant of is this into a simulation modelsimulation model
But is it based on optimisation – and of what sortBut is it based on optimisation – and of what sort?? Type of utility function s crucialType of utility function s crucial GokhaleGokhale et al. (2001) et al. (2001): strong conclusions based on “accidental : strong conclusions based on “accidental
bequests”bequests”
What characteristics of the simulation model?What characteristics of the simulation model? representative agentrepresentative agent size and length of the runsize and length of the run criteria for evaluationcriteria for evaluation
Type of solution?Type of solution? convergence to equilibrium?convergence to equilibrium? an equilibrium distribution?an equilibrium distribution?
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Illustrative model (2)
Focus on the role of consumptionFocus on the role of consumption naïve savings behaviournaïve savings behaviour family features absentfamily features absent (Champernowne-Cowell 1998) (Champernowne-Cowell 1998)
A model of single person-dynastiesA model of single person-dynasties person inherits person inherits TT years after attaining adulthood years after attaining adulthood dies dies TT years after inheritance years after inheritance leaves all his terminal wealth to one descendantleaves all his terminal wealth to one descendant
Wealth left in excess of Wealth left in excess of WW* * taxed at rate taxed at rate During the earnings all get the same earnings, During the earnings all get the same earnings, EE**
Individuals consume:Individuals consume: CC** if they have positive wealth if they have positive wealth otherwise otherwise EE**
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Link between generations
0-T Tn =0
0-T Tn =1
0-T Tn =2
0-T Tn =3
B0 − tax
B1
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Wealth over the lifetime and bequests Given savings rule and inherited wealth Given savings rule and inherited wealth WW(0) we get(0) we get ^ ^ ^ ^ WW((tt) = max { ) = max { WW(0) e(0) ertrt BB [e [ertrt 1], 0}, 1], 0}, B B := [:= [CC* * EE*]/*]/rr ^̂ Wealth rises/declines according as Wealth rises/declines according as WW(0) (0) BB At end of life bequest is At end of life bequest is BBnn = = WW((TT))
But initial wealth for next generation is But initial wealth for next generation is
WW(0) =min {(0) =min {BBn n , [1, [1BBn n + + WW* }* }
Evaluating at end of next generation:Evaluating at end of next generation: ^ ^ BBnn+1+1 = max {min {= max {min {BBn n , [1, [1BBn n + + WW** } e } erTrT BB [e [erTrT 1], 0}1], 0}
Change in bequest Change in bequest BBnn+1+1 = = BBnn+1+1 − − BBnn as a function of as a function of BBnn Get three possible regimesGet three possible regimes
1.1. where where WW((tt) = 0) = 02.2. where where WW((tt) > but ) > but BBn n < < WW**
3.3. where where BBn n > > WW**
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Bequest Dynamics
Bn falling Bn fallingBn rising
Bn10050 150 200 250 300
Bn
StableStableStableStable
UnstableUnstable
oW*B̂
-40
-30
-20
-10
10
20
30
40
0
The phase diagram Paths to riches Paths to ruin Find equilibria (B = 0) Now cut tax…
Plot B against B
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Wealth distribution overall
0
0.0025
0.005
0.0075
0.01
0.0125
0.015
0.0175
0.02
0.0225
0 50 100 150 200 250
f(W)
W
Distribution of W amongst wealthy
Take into account lower equilibrium
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Illustrative model (3) Focus on family formation (Focus on family formation (ChampernowneChampernowne-Cowell 1998-Cowell 1998) )
each generation is a discrete uniteach generation is a discrete unit pairs always consist of people with equal wealthpairs always consist of people with equal wealth no-one benefits from more than one bequestno-one benefits from more than one bequest bequest is divided equally amongst the bequest is divided equally amongst the kk kids ( kids (kk given) given)
Model applies to upper wealth levels Model applies to upper wealth levels above some specified wealth above some specified wealth level level WW**
For any For any W>WW>W**, the proportion of testators with , the proportion of testators with kk kids is kids is ppkk, , independent of independent of WW ppkk ≥ 0 ≥ 0 k k ppkk = 1 = 1 k k kpkpkk = 2 = 2 two examples:two examples:
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Equilibrium distribution LetLet F Fn n ,, FFnn+1+1 be the wealth distribution in generations be the wealth distribution in generations n n , , nn+1+1
FFnn((WW) is the proportion of the population in generation ) is the proportion of the population in generation nn with wealth with wealth WW We have equilibrium if We have equilibrium if FFnn = = FFnn+1+1 = F = F
Take a person with wealth W in a family where the parents had k kids if parental wealth was W' per head bequest must have been 2[1−]W' so each kid would get 2[1−]W'/k therefore W' = kW/ 2[1−] given that there are pk such families: Fn+1(W) = k ½k pk Fn(kW/ 2[1−])
Equilibrium requiresF(W) = k ½k pk F(kW/ 2[1−])
Only functional form that permits a solution for all W is ParetianF(W) = 1−AW
So the equilibrium condition is:
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Tax and Equilibrium Wealth Distribution
(i) Narrow (ii) Wide(%) Gini Gini 2 1.22 0.410 - - 5 1.55 0.323 1.42 0.35210 2.11 0.237 1.90 0.26315 2.73 0.183 2.44 0.20520 3.43 0.146 3.07 0.16325 4.28 0.117 3.86 0.130
Higher tax produces lower long-run inequalityHigher tax produces lower long-run inequality If tax is too low – no long-run equilibrium If tax is too low – no long-run equilibrium Quite low tax rates produce values similar to actual economies.Quite low tax rates produce values similar to actual economies.
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Equilibrium Distribution = 10%
0
0.001
0.002
0.003
0.004
0.005
0.006
0.007
0.008
0.009
200 250 300 350 400 450 500 550 600 650 700 750 800
Wealth
freq
uenc
y
=2.113 (Narrow family spread)
=1.9002 (Wide family spread)
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Summary
Dynastic model produces a bifurcationDynastic model produces a bifurcation Convergence to equilibrium distributionConvergence to equilibrium distribution Inequality within and between groups Inequality within and between groups Source of inequality lies in savings behaviourSource of inequality lies in savings behaviour
Role of uncertainty captured in savings behaviourRole of uncertainty captured in savings behaviour Family structure affects long-run equilibriumFamily structure affects long-run equilibrium
spread out families reduce effectiveness of taxation spread out families reduce effectiveness of taxation
Tweaking the models would modify this a littleTweaking the models would modify this a little Variation in income Variation in income Out-of-class marriageOut-of-class marriage ((ChampernowneChampernowne-Cowell 1998-Cowell 1998))
Potentially major role for taxationPotentially major role for taxation
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