Tax and transfer to reduce inequality

I have blogged repeatedly about the critical role played by government transfers in reducing inequality and the unsustainability of economic growth in conditions of high inequality. However, transfers require tax revenues. This highlights the importance of taxation in addressing poverty and creating conditions for sustainable economic growth. The graphic below from The Economist draws attention to this.



In most European nations, the poverty rates are lower only because of the significant role played by government transfers. Transfers nearly halve poverty rates in these countries. Contrast this with the United States where the lower extent of transfers are responsible for keeping poverty rates high.

The role of taxes and transfers is even more pronounced with inequality measures. Similar trans-Atlantic trends persist with inequality reduction due to taxes and transfers. In case of many developing countries, as the cases of Mexico, Brazil, and Chile show, the low levels of transfers contribute towards their poverty and high inequality rates.

Update 1 (10/5/2014)

Jared Bernstein uses data from a CBO report to show that,

For middle-income households, transfers and lower taxes explain the vast majority of their income growth in recent decades. Their earnings have declined in real terms 7 percent from 1979 to 2010, but Social Security, Medicare, unemployment insurance and lower taxes have more than made up the difference... After accounting for taxes, middle incomes rose about 36 percent, from 1979 to 2010. But here’s the kicker: 90 percent of that increase came from higher transfers (74 percent) and lower taxes (16 percent). And remember, we’re talking middle-class families here, not poor ones... The share of comprehensive income going to the top 1 percent grew 6 percentage points before taxes and transfers from 1979 to 2010, and 5.4 points after taxes and transfers. (If one stops at 2007, before the recession, the same comparison yields an increase of 9.8 points before tax and 9.3 after).

Update 1 (18/11/2014)

Times has a nice story that points out that before taxes and transfers, the US does no worse than its western counterparts. Once taxes and government transfers are factored in, the US rises to the top in the inequality ladder. 

Total taxes as a share of GDP is among the lowest in the US.