Public Economics and Inequality:

Uncovering our Social Nature

AEA Distinguished Lecture

Emmanuel Saez

UC Berkeley

January 2021

1

INTRODUCTION

Standard economics is based on rational and self-centered in-

dividuals interacting through markets

But we are also social individuals at many levels (families,

workplaces, communities, nations) who care about inequality

In advanced economies, we pool 30-50% of incomes through

government using taxes to fund public goods and transfers

Standard public economics: government intervention justified

to address (a) market failures, (b) inequality

This lecture: Our social nature helps understand public eco-

nomics in action and concerns for inequality

2

20%

25%

30%

35%

40%

45%

50%

1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020

Top 10% Pre-tax Income Share in the US, 1913-2018

Top income shares of pretax national income among adults aged 20+ (income within couples equally split). Source is World Inequality Database wid.world (from Piketty, Saez, Zucman 2018).

US pre-tax

20%

25%

30%

35%

40%

45%

50%

1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020

Top 10% Income Shares in the US and France, 1910-2018

Top income shares of pretax national income among adults (income within married couples equally split). Source is Piketty, Saez, Zucman (2018) for US and Piketty et al. (2020) for France.

US pre-tax

France, pre-tax

0%

10%

20%

30%

40%

50%

60%

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P95-9

9

P99-9

9.9

P99.9

-99.99

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9-99.9

99

P99.9

99-10

0

Average tax rates by income group in 2018: US vs. France(% of pre-tax income)

United States

France

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Average tax rates by income group in 2018: US vs. France(% of pre-tax income)

United States

France

US in 1970

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50%

1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020

US Top 10% Income Shares pre-tax vs. post-tax, 1913-2018

Top income shares of pretax and posttax national income among adults (income within married couples equally split). Source is Piketty, Saez, Zucman (2018) for US and Piketty et al. (2020) for France.

US pre-tax

US post-tax

20%

25%

30%

35%

40%

45%

50%

1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020

US Top 10% Income Shares pre-tax vs. post-tax, 1913-2020

Top income shares of pretax and posttax national income among adults (income within married couples equally split). Source is Piketty, Saez, Zucman (2018) for US and Piketty et al. (2020) for France.

US pre-tax

US post-tax

Covid (guess)

20%

25%

30%

35%

40%

45%

50%

1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020

Top 10% Income Shares in the US and France, 1910-2018

Top income shares of pretax and posttax national income among adults (income within married couples equally split). Source is Piketty, Saez, Zucman (2018) for US and Piketty et al. (2020) for France.

France, post-tax

US pre-tax

US post-tax

France, pre-tax

PREHISTORY: HUNTER-GATHERER SOCIETIES

Hunter-gatherer societies span over 90% of human history

Small and fairly egalitarian with minimal private wealth andleaders with limited power (Boehm 1999)

Community cooperation and sharing common for many tasks:hunting, access to natural resources, warfare

Sharing norms through customs and reciprocity (not markets)

Children, elderly, and sick care mix of family and community

Implicit pooling of economic resources likely high (' 50%)

Labor supply motivated by reciprocity, joy of work, social ap-probation and status

10

HISTORY: RISE OF FORMAL STATE

1) Rise of coercive state in 3000BC: agricultural communi-

ties become despotic kingdoms, invent taxes and forced labor

to serve power of hierarchical state (Scott 2017)

Size of government fairly small up to 1900: taxes less than

10% of output to support state public goods not social state

Social support for children, elderly, sick, needy shrinks down

to family (and church)

2) Rise of social state in 20th century: mass education,

retirement benefits, modern health care, income support

Pooling of resources large again: taxes ' 30-50% of income

11

0%

10%

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30%

40%

50%

60%

1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2018

Tax

reve

nue

/ nat

iona

l inc

ome

The rise of the fiscal state in rich countries 1870-2018

Sweden

France

Germany

Britain

United States

Total tax revenue (all taxes and social contributions at all levels of government) divided by national income. Sources and series: Piketty, Capital and Ideology, 2020, Figure 10.14, updated to 2018t

0%

10%

20%

30%

40%

50%

1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

Perc

ent o

f nat

iona

l inc

ome

The Rise of the Social State in Europe, 1870-2015

Other social spendingCash social transfersHealth careRetirement+disability benefitsEducationRegalian public goods

6%

10%

11%

Source. Piketty (2020, Figure 10.15). Average for Germany, France, Britain and Sweden. Cash social transfers include unemployment benefits, family benefits, and means-tested benefits. Other social spending includes in-kind spending such as public housing. Regalian public goods includes defense, law and order, administration, infrastructure.

9%

8%

6%

5%

2%

6%

1%

47%

RISE OF THE SOCIAL STATE IN 20TH CENTURY

Government growth due to rise of social state taking care of:

1) The young with public education and childcare

2) The old with public retirement benefits

3) The sick with universal health care

4) Those in need (disabled, unemployed, poor) with specific

programs

Society supports those who cannot directly support themselves

⇒ Huge direct and indirect equalization effect

14

SOCIAL STATE VS. STANDARD ECON

Standard economics: absent social state, rational individuals

in a market economy can manage on their own:

1) Parents or young can borrow to pay for education

2) Workers can save for retirement

3) People can buy health care insurance

4) People can accumulate a buffer stock to absorb shocks

Empirical evidence and behavioral economics: Individuals are

not good at making such plans on their own

15

EDUCATION

Education most important driver of long-term economic growth

Mass modern education is always government driven:

Compulsory schooling which in turn requires public funding(otherwise low income parents can’t pay)

⇒ All children get basic education and opportunity

Higher education capacity built through public universities andis a key engine of social mobility

⇒ Education choices made at social (not individual) level

Privatization failures: (1) student debt often unbearable bur-den and (2) predatory for-profit schools

16

0%

20%

40%

60%

80%

100%

1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930

School enrollment at ages 5-14, 1830-1930

US

Prussia

France

Fraction of children aged 5-14 enrolled in school (public or private). Sources and series: Lindert (2004) Growing Public and Historical Statistics of the US

0%

20%

40%

60%

80%

100%

1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930

School enrollment at ages 5-14, 1830-1930

US

US blacks

Prussia

France

Fraction of children aged 5-14 enrolled in school (public or private). Sources and series: Lindert (2004) Growing Public and Historical Statistics of the US

Slavery and school prohibitionend

0%

20%

40%

60%

80%

100%

1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990

Primary School Enrollment in Russia, Korea and Indonesia

Fraction of children enrolled in primary school (public or private). Source: Lee and Lee (2016).

Indonesia compulsory primary education

Korea compulsory primary education

Russia compulsory primary education

RETIREMENT BENEFITS

Elderly lose ability to work and hence need to be supported

Economists’ solution: workers should save for retirement

Behavioral economics: individuals fail to save on their own

Actual solution: mandatory public retirement systems funded

by taxes (replace older family based support)

Even privatized social security has mandatory contributions

Retirement is solved at social (not individual) level

Large cross sectional redistribution (even if lifetime redistribu-

tion modest as benefits related to prior earnings)

20

0%

20%

40%

60%

80%

1850 1860 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980

Employment Rates of Men Aged 65+, 1850-1980

US

France

Gainful employment of men aged 65 and above. Sources: Reproduced from Costa (1998), Table 2A.2

Civil war vets pensions

US social security starts

0%

20%

40%

60%

80%

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Employment Rates of Men Aged 60-64, 1970-2019

Source: OECD database online.

US lowers early retirement age from 65 to 62 in 1961

Germany lowers retirement age from 65 to 60 in 1975,

increases it to 65 in 2000s

HEALTH CARE

All advanced economies (but US) provide universal health care

Health care costs funded mostly by taxation (as lower incomeswould not be able to pay)

⇒ Significant redistribution by income, health, and health risk

Why same health care for all? Saving actual lives is imperative

Even in US, private system relies heavily on employers. Oba-macare employer mandate is a privatized poll tax on workers

⇒ Health care is solved at social (not individual) level

Behavioral economics shows that private health insurance chal-lenging to navigate (Chandra et al. 2019)

23

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99

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Average tax rates by income group in 2018: US vs. France(% of pre-tax income)

United States

France

US adding private health insurance

INCOME SUPPORT PROGRAMS

Income support targeted to specific groups (unemployed, dis-

abled, poor elderly, poor children)

Untargetted means-tested support generally modest, in-kind

(housing, nutrition) and combined with job training help

Widespread social view that people who can support them-

selves do not deserve support (does not bode well for UBI)

Distribution and fairness more important than efficiency in

public views (Stantcheva 2020)

Fairness (resenting “free loaders” or “tax cheats”) is our in-

tuitive way to reduce efficiency costs of behavioral responses

25

SCOPE OF REDISTRIBUTION: US VS. OTHERS

Pooling of resources through taxes is big within country but

minuscule across countries

Direct foreign aid from rich countries is small (.25% of GDP in

US), targeted to crises, security, development and unpopular

EU budget is only 1% of EU economy, transfers controversial

Social state smaller when country divided along ethnic lines

(e.g. Alesina-Glaeser 2004 for US vs. EU)

⇒ Social group scope matters a lot and is malleable

26

LABOR SUPPLY

Concern that taxes funding social state could discourage work

Standard econ view: labor supply l(w,R) coming out ofmaxu( c

+, l−

) st c = wl + R is highly incomplete

Social determinants of labor supply:

a) Youth labor is regulated by labor laws/education

b) Old age labor regulated by retirement programs

c) Female market labor driven by norms + child care policy

d) Hours of work regulated by overtime + vacation mandates

Social labor supply with disutility for youth, old, overtime labor

27

0%

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40%

60%

80%

100%

15-19

20-24

24-29

30-34

35-39

40-44

45-49

50-54

55-59

60-64

65-69

70-74

75-79

80+

Employment Rates of Men by Age, 2019

US

France

Source: OECD database online. Employment to population ratios.

0%

20%

40%

60%

80%

100%

15-19

20-24

24-29

30-34

35-39

40-44

45-49

50-54

55-59

60-64

65-69

70-74

75-79

80+

Employment Rates of Women by Age, 2019

US

France

Source: OECD database online. Employment to population ratios.

0%

20%

40%

60%

80%

100%

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Employment Rates of Men and Women, aged 25-54

Netherlands men

France men

US men

Source: OECD database online.

0%

20%

40%

60%

80%

100%

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Employment Rates of Men and Women, aged 25-54

Netherlands men Netherlands women

France men France women

US men US women

Source: OECD database online.

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

1940 1945 1950 1955 1960 1965

US female labor force participation, age 16-64

Source: Historical Statistics of the United States (Current Population Reports).

25% increase in 1943-1945 during

WW2 planned economy

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

1940 1945 1950 1955 1960 1965

US female labor force participation, age 16-64

Source: Historical Statistics of the United States (Current Population Reports).

25% increase in 1943-1945 during

WW2 planned economy

1,000

1,200

1,400

1,600

1,800

2,000

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Average Annual Hours of Work of Employees

United States

France

Source: OECD database online. Includes all ages, genders, and part-time, full-time, overtime.

1968: 4th weekof paid vacation

1982: 5th week+ 39 hours/week

2000-2: 35 hours/week

US has 40 hour/week and no mandatory paid vacation

LABOR SUPPLY AND TAXES/TRANSFERS

Labor supply responses to taxes/transfers generally modest

for groups expected to work

Labor supply responses can be large for groups less attached

(elderly, single mothers) but highly affected by social context:

1) German retirees heavily influenced by statutory retirement

ages over and above financial incentives (Seibold 2020)

2) US single mothers responded strongly to welfare+EITC

reforms of 1990s but not other EITC reforms (Kleven 2020)

3) Responses can be much larger when employers have incen-

tives to accommodate responses

35

Labor Force Participation of Single WomenWith and Without Children

14.5pp

14pp

50 years of relative stability,apart from these 5 years

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Par

ticip

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n (%

)

68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18Year

With Children Without Children

Annual Employment Low Education15 / 167

Source: Kleven (2018)

aged 20-50

SUMMARY ON SOCIAL STATE

Education of the young, health care for the sick, retirementsupport for the old, and income support for the needy, aredone through the social state

Humans struggle to solve these problems individually but aregood at solving these issues collectively through social state

Social state leaves room for individual choice but shapes theoverall outcome

Social state also has large impact on labor supply but a lot ofit intentional (young, old, overtime) rather than unintendedmoral hazard

Our social nature is not limited to government and this shapespre-tax inequality

37

NON-GOVT SOCIAL INSTITUTIONS

Many private institutions preexist/supplement the social state:

1) Households (often modeled as single economic unit)

2) Villages in devo countries (Townsend); Common-pool re-source groups to manage public goods (Ostrom); voluntarycommunes such as Israeli Kibbutz (Abramitzky)

3) Nonprofit organizations (charitable contributions and not-for-profit services/products)

4) Modern large employers:

(a) absorb risk and offer steady work and compensation

(b) fill gaps in social state (pensions and health in US)

38

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Average tax rates by income group in 2018: US vs. France(% of pre-tax income)

United States

France

US adding charitable giving

SOCIAL BEHAVIOR

Social = taking a group perspective instead of individual

Household is the basic example standard in economics

But most economic behaviors have social aspects: teamwork

production, etc.

Such contexts require cooperation with potential tension be-

tween group vs. individual goals

Cooperation can be Authoritarian or Egalitarian

Economics focuses on market solutions and pricing external-

ities but setting up markets is too costly in many contexts

(Coase)

40

HOW IS COOPERATION SUSTAINED?

Cooperation benefits group but faces 2 challenges:

(a) the classic “social dilemma” (how to achieve efficiency)

(b) how to distribute gains (equity issue).

Sustained through various ways:

1) Social preferences: Altruism and reciprocity (e.g. family)

2) Social authority (e.g. hierarchy, social norms, rules)

3) Fairness: Acceptable distribution

4) Resent and punish non-cooperators

41

LAB EVIDENCE ON COOPERATION

(a) COOPERATION IN PRODUCTION

Public good game: 50% contribute to public good insteadof playing selfish Nash. Willingness to pay to punish the selfish

Effort reciprocity: recipients work harder for employer whenemployer more generous (Fehr-Kirchsteiger-Riedl)

(b) DISTRIBUTION OF SURPLUS

Dictator game: 2/3 of “dictators” share part of endowmentwith recipient (50/50 sharing most common)

More sharing if recipient helped create endowment or is needy

Ultimatum game: recipients refuse offers that are too un-equal and proposers tend to offer close to equal split

42

Dictator games: a meta study 589

Fig. 1 Distribution of mean giving per treatment

Fig. 2 Distribution of individual give rates

information on a host of independent variables, this is a strong indicator that meta-regression is preferable over mere meta-analysis.

Finally, using the supplementary dataset with reconstructed individual observa-tions, we learn that contributions are very unevenly distributed over the unit interval,see Fig. 2. 36.11% of all participants give nothing to the recipient. 16.74% choosethe equal split. As many as 5.44% give the recipient everything.

Dictator games: a meta study 599

Fig. 9 Society of origin

tion patterns basically distribute over the range [0, .5]. All bilateral comparisons ofdistributions are statistically significant: Epps Singleton, p < .0001.

Age also has a strong effect. If one codes children with 0, students with 1, middle-aged adults with 2, and the elderly with 3, there is a highly significant, substantialeffect: meta-regression, cons .187∗∗∗, age .098∗∗∗, N = 445, adj.R2 .038. If onetreats each age class as a categorical variable, in meta-regression, the behaviour ofchildren is not significantly different from the behaviour of students, while there is asignificant difference with respect to the remaining age classes: meta-regression, cons.269∗∗∗, child .036, middle age .138∗∗, elderly .443∗∗∗, N = 445, adj.R2 .122. Againdistributions are more informative than means. Children are unlikely to give morethan half of the pie, and many give less. This explains why there is no difference inmeans, compared to students. Yet children are much less likely to give nothing. Giv-ing nothing is even rarer in participants of middle age, and it never happens in theelderly. For people of middle age, the equal split is the mode, while for the elderlythis is giving everything. All bilateral comparisons of distributions are statisticallysignificant: Epps Singleton, p < .0001.

5 Multiple regression

In single regression most effects turns out significant. Yet single regression has littleexplanatory power. This becomes patent through the measure for the adjusted R2.In most regressions, it is below .1, implying that more than 90% of the varianceremains unexplained. Compared to the meta-analysis of means, which left 97.1% of

INEQUALITY WITHIN THE FIRM

Production within firm requires cooperation and splitting of

product

Standard theory: perfect cooperation in production and cost-

less matching ⇒ wage = marginal product

Contract theory questions perfect cooperation and search the-

ory introduces matching costs

With costly matching: wage can be anywhere in range defined

by outside options

⇒ Leaves room for social effects and distributional conflict

45

CONSEQUENCE: RIGID COMPENSATION RULES

Individual contributions to production often hard to measure

and bargaining over surplus is costly

⇒ Rigid compensation rules are common

Pay scales, cost-of-living adjustments, uniform pay raises

Wages downward rigid even in recessions because pay cuts

hurt morale and cooperation of workers (Bewley 1999)

Wages sticky to payroll taxes at individual level

But also 2/20 rules for hedge fund managers, equal sharing of

credit among academic authors, etc.

The compensation rules affect pre-tax inequality

46

PRE-TAX DISTRIBUTION FIGHT IS CRUCIAL

Owners+workers jointly create economic surplus within firms

⇒ Natural and historical place where distributional fight hap-pens (with government being the partial referee)

Union bargaining play(ed) central role in most countries in

wage setting sometimes institutionalized through labor boards

US public: inequality should be solved by private sector rather

than government, jobs should pay living wages (McCall ’13)

Minimum wage is popular across the board (in the US, 25/27

state level ballots won since 1996 in both red and blue states)

Tax the rich ballot initiatives much less successful47

AK

AZ

AZAR

AR

CA

COCO

FL

FL

IL

ME

MO

MO

MO

MT

MT

NE

NV

NJ

OHOR

OR

SD

WA

WA

.3.4

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ting

yes

-.1 -.05 0 .05 .1 .15Republican lean in closest presidential election

25 out of 27 Min Wage ballots have won since 1996

MAMI

WA

MA MIOROR

OR

CA

MAMA

CALA

OR

CA

WA

CA

ME

CA

CO

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-.15 -.1 -.05 0 .05 .1Republican lean in closest presidential election

Tax increase at top only Broader tax increase

Most income tax increase ballots since 1971 have failed

NORMATIVE CONSEQUENCES

1) Revealed individual preferences may not be informative of

social preferences

2) Replacing social institutions by markets+individual choice

might not always work well (e.g., retirement, education)

3) Social system functions best when individuals internalize

the social objective

⇒ better to eliminate than face the equity-efficiency tradeoff

4) More possibilities than economists generally think

50

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Alvaredo, F., Atkinson, A., T. Piketty, E. Saez, and G. Zucman WorldInequality Database, (web)

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Bewley, Truman F. 2009. Why Wages Don’t Fall During a Recession.Cambridge, MA: Harvard university press.

Blundell, Richard, Eric French, and Gemma Tetlow. 2017 “RetirementIncentives and Labor Supply.” In John Piggott and Alan Woodland eds.,Handbook of Population Aging, Amsterdam: North Holland.

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