James B. Davies

The distribution of wealth

This chapter is concerned with the distribution of personal wealth, which usually refers to the material assets that can be sold in the marketpace, although on occasion pension rights are also included. We summarise the available evidence on wealth distribution for a number of countries. This confirms the well known fact that wealth is more unequally distributed than income, and points to a long term downward trend in wealth inequality over most of the twentieth century. We also review the various theories that help account for these feature. Lifecycle accumulation is one popular explanation of wealth differences, but inheritance is also widely recognised as playing a major role, especially at the upper end of the wealth range. A recurrent theme in work on wealth distribution is the relative importance of these two sources of wealth differences. We discuss the results of studies that assess the contributions of inheritance and lifecycle factors, and give attention also to a variety of related issues, such as the link between wealth status across generations, and the possible motives for leaving bequests.

Optimal grouping of income and wealth data

Abstract Optimal grouping of income and wealth data under the general criterion of maximizing an inequality index for the grouped data is investigated. This approach guarantees that the optimal groups correspond to nonoverlapping income ranges and minimizes the loss of distributional detail. An algorithm is provided which will identify the optimal grouping arrangement precisely when the Gini coefficient is used. The algorithm is applied to a large microdata set, Statistics Canadas 1984 Survey of Consumer Finance, which reports both income and wealth. ‘Official’ and optimal groupings are compared, and guidelines are suggested for devising groupings which may in practice approximate the optimal arrangement.

The Relative Impact of Inheritance and Other Factors on Economic Inequality

An empirically grounded micro-simulation of saving, with bequests related negatively either in total to average childrens income or separately to individual childrens incomes, is constructed for a single generation in a steady growth economy. Behavioral parameters are set so that predicted bequests to the next generation are consistent with both the scale and assignment of inheritances (taken from a real-world source) for the simulation generation. The relative impact of inheritance and other factors on different aspects of economic inequality is assessed. While inheritance is a major cause of wealth inequality, its influence on annual income and lifetime resources is small, and in the latter case ambiguous. … Inheritance perpetuates and may intensify inequalities arising originally from other causes. In that sense, it is a secondary cause of inequality; but that is not, of course, to say that it is of secondary importance. The extent of its influence on distribution remains an open question, which cannot be decided merely by theoretical reasoning … but requires in addition something in the nature of a quantitative analysis of the relevant facts. -Wedgwood, 1929, pp. 60–61.

Social security, longevity, and moral hazard

Abstract Recently, several authors have argued that social security can have positive effects on savings and welfare when individuals possess hidden information about their longevity, that is when there is adverse selection in annuity markets. This paper considers the related problem of the effects of social security when individuals can take hidden actions to affect their longevity, that is when there is moral hazard in annuity markets. In contrast to the adverse-selection models, we show that social security never raises welfare in a pure moral hazard economy. As well, social security may either increase or reduce longevity, depending on the characteristics of the health- related goods consumed. It is suggested that a complete analysis of social security needs to consider both adverse selection and moral hazard.

Flat rate taxes and inequality measurement

Abstract Tax flattening exercises which include an increase in personal allowances have been pervasive over the past two decades. Such changes, which typically benefit both the poor and the rich, at the expense of the middle class, have complex redistributive effects which are not obviously ‘equalizing’ or ‘disequalizing’. We develop a systematic approach to comparing the relative inequality of flat rate tax schemes to conventional graduated rate taxes. We provide an illustrative example using 1993 U.S. taxfiler data.

Gender Bias, Investments in Children, and Bequests

The impacts of pure sex preference and differential earnings opportunities by gender on investments in children are modelled with altruism. If bequest constraints do not bind human investments are privately efficient, with the higher-earning gender receiving more education. Education does not depend on parental wealth. The gender differential in bequests is ambiguous, however, even in this case. When bequest constraints bind education may depend on wealth and it is also possible for the gender with better earnings opportunities to get less education. The model is tested with data from Philippine villages where bequest constraints are generally nonbinding. The schooling differential slightly favors daughters. Estimated bequest behavior, however, reflects pure sex preference in terms of our model. Copyright 1995 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Intergenerational Mobility under Private vs. Public Education

Intergenerational earnings mobility is analyzed in a model where human capital is produced using schooling and parental time. In steady states more mobile societies have less inequality, but in the short run higher mobility may result from an increase in inequality. Starting from the same inequality, mobility is higher under public than under private education. A rise in income shocks, for example due to increased returns to ability, or a switch from public to private schooling both increase inequality. However, increased shocks raise mobility in the short run and do not affect it in the long run, whereas an increased role for private schooling reduces mobility in both the short and long run. That these differences may help to identify the source of changes in inequality, and other real-world implications, are illustrated in a brief discussion of time trends and cross-country differences.

Consumption vs. income taxes when private human capital investments are imperfectly observable

Abstract This paper considers optimal taxation in an endogenous growth model where private education investments are imperfectly observable. Consumption taxation is better than labor income taxation for public provision of goods unless educational investment is completely unobservable. If subsidies are feasible for observed education investment, the consumption tax rate is independent of the degree of observability but the subsidy rate is higher the lower is the observability. If subsidies are not feasible, the consumption tax rate is lower the more limited is the observability. Optimal tax rates for goods that provide consumption and education investment simultaneously are below normal rates for observed pure consumption. Growth and welfare are positively related to (independent of) the degree of observability without (with) subsidies.

Explaining Intergenerational Transfers

The importance of transfers of goods, services and cash between parents and children has long been apparent. Nonetheless many economists were surprised when Kotlikoff and Summers (1981) reported their estimate that 80% of the household wealth of the United States is due to inheritance rather than life-cycle saving. Despite counterclaims (e.g., by Modigliani, 1988), it is now generally acknowledged that a large fraction of saving is not destined for consumption in retirement, but gives rise to bequests. In addition, Cox (1987) has reported that the annual flow of gifts intervivos exceeds that of bequests in the U.S. by a considerable margin. The importance of parental inputs into formation of human capital is universally recognized. Finally, the work by Bernheim, Shleifer and Summers (1985) (BSS), Cox, and others has focused attention on flows of services in kind between parents and children. In short, we are now well aware that intergenerational transfers are quantitatively very important.

Measuring Marginal Income Tax Rates for Individuals in Canada: Averages and Distributions Over Time

Average marginal tax rates (AMTRs), and the dispersion of marginal tax rates across income groups, for Canada over 1947-91 are reported. Federal AMTRs fluctuated with little trend from 1947 to the mid-1960s, rose to the mid-1970s, fell, and then rose from the early 1980s through to 1991. Federal plus provincial AMTRs trended upward after 1949, increasing fastest from the mid-1960s to the mid-1970s. Relative dispersion of MTRs shows a strong downward trend over the sample period. This compression has been due partly to a decline in top MTRs, but the main influence has been the steady increase in the portion of the population, and of income, subject to tax. The AMTR time series is quite volatile. Difference stationarity is not rejected.