American inequality reflects gross incomes as much as taxes

WHEN PEOPLE think about which rich countries have the least equal income distributions, America often jumps to mind. The country has a much smaller welfare state than many of its European counterparts, which suggests it does not redistribute much. But does it?

One common measure of income inequality is the Gini coefficient. The index ranges from zero to 100. A score of zero implies that income is shared equally; 100 implies that one person scoops the lot. By comparing a country’s Gini coefficient before and after taxes and transfers, a rough gauge can be created of how progressive (or regressive) its tax and benefit system is.

By this measure at least, America’s tax system is in fact fairly progressive. It does roughly as much to reduce inequality as does Canada’s or Sweden’s (even though most European systems do more). What distinguishes America from those two countries is that its pre-tax Gini coefficient is high, so that the government has to put in more work to level the playing field. In contrast, countries with low pre-tax inequality, such as South Korea, manage to achieve low post-tax inequality without doing much by way of redistribution.

The difference in countries’ Gini coefficients after taxes and transfers correlates strongly with the economic weight of government. In France government spending accounts for 57% of GDP. America’s federal, state and local authorities spend just 35%. Although pre-tax inequality is almost as high in France as in America, the two countries look very different after taxes.

Nordic countries are generally thought to be champion redistributors. But within the OECD, a club of mostly rich countries, Ireland does most to slash inequality. After taxes and transfers, Ireland’s income distribution goes from the most skewed in our chart to the middle of the pack. The rich pay a higher share of income tax than in most other countries, while low-earning households receive generous tax credits.

Most countries would struggle to copy the Irish system in full. Part of the reason Ireland is able to do so much redistribution is that it relies more than most on taxes paid by multinational companies. Foreign-owned firms accounted for 80% of corporate tax in 2017. Cross-country data suggest that if America wanted to bring its level of inequality down to the OECD average, it would have to boost government spending to 50% of GDP. That would require increases in taxes across the board—a highly unlikely prospect.

Sources: IMF; OECD; Central Statistics Office Ireland