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Measuring Preferences for Redistribution and Fairness: An Experimental Approach Ruben Durante Louis Putterman Brown University.

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Presentation on theme: "Measuring Preferences for Redistribution and Fairness: An Experimental Approach Ruben Durante Louis Putterman Brown University."— Presentation transcript:

1 Measuring Preferences for Redistribution and Fairness: An Experimental Approach Ruben Durante Louis Putterman Brown University

2 Stylized Facts Luxembourg income survey data for OECD countries shows post-tax-and-transfer income share of bottom 40% is 14.7 percentage points above their pre-tax-and-transfer share (Milanovic, 2000) Even in the U.S. the post-tax income shares of the bottom 40% is 7.8% higher than the pre-tax. There are considerable differences across countries.

3 Big Questions Why do we observe redistribution in democracies? Why don’t we observe more of it? Why does the amount of redistribution vary among countries? These questions motivate our study, but we try to address more specific subsidiary questions.

4 To know what determines the amount of redistribution, we need to know what accounts for redistribution in the first place.

5 Possible reasons for redistribution: 1.Simple self-interest (the poor and middle class vote to redistribute from the rich). 2.Insurance motive (all risk-averse people may favor a system of social insurance) 3.Desire to reduce inequality a. out of fear of social instability b. out of social preference (“inequality aversion”)

6 Possible limits on redistribution 1.Concern for negative impact on incentives, other dead weight losses. 2.Belief that inequalities are justly earned. 3.Disproportionate political influence of the rich.

7 main goal of our experiment is to investigate relative importance of : 1.Simple self-interest (the poor and middle class vote to redistribute from the rich). 2.Insurance motive (all risk-averse people favor a system of social insurance) 3.Desire to reduce inequality (a. out of fear of social instability) b. out of social preference (“inequality aversion,” “fairness preference”)

8 we also obtain evidence on two of the limiting factors: 1. Concern for negative impact on incentives, other dead weight losses (although there’s no production or investment in the experiment, we can study concerns over exogenous changes in size of the pie) 2. Belief that inequalities are justly earned. (3. Disproportionate political influence of the rich – not considered)

9 the experimental literature There are many experiments bearing on fairness and other distributive preferences (e.g., dictator games, ultimatum games, trust games, moonlighting games, Charness & Rabin’s “simple games,” etc.) but usually these involve only two or three subjects interacting and have no suggestion or reference to the macro/political issue of redistribution in society.

10 experiments to measure preferences for societal income equalization At least half of these (e.g., Amiel and Cowell) elicit preferences survey style, rather than in a manner that determines actual payoffs. Others (Beck; Beckman, Formby & Smith; Ackert, Martinez-Vasquez & Rider) use real payoffs but lack one or more elements of our experiment, such as:

11 - the group of affected individuals is large (we use group size 20 + a dictator) - decisions are made both as a disinterested observer, as an interested party under uncertainty, and as an interested party after resolution of uncertainty about own income - decisions are made with respect to initial incomes determined both arbitrarily and in “earned income” conditions - the variation in pre-tax incomes is very large (from max of $100 to min of $0.11)

12 - decisions are made with both different dead weight losses and with different private costs to the dictator, to study demand (willingness to pay) - Unlike Frohlich and Oppenheimer and others, we don’t explicitly ask subjects to think about their fairness or redistributive beliefs (until the debriefing), but we provide one mild framing cue (our pre-tax income distribution mimics that of income 5-percentiles in the U.S., and we tell our subjects that this is so).

13 tax scheme The pre-tax-and-transfer distribution of income can be modified by a proportionate tax of 0, 0.1, 0.2, … 0.9, 1.0, with the tax proceeds (or the proceeds minus an exogenously imposed dead weight loss) redistributed equally among the twenty affected subjects.

14 We use a strategy-type method in which every subject potentially dictates the degree of redistributive taxation under each condition, so as - to maximize the amount of data generated - to avoid strategic voting issues

15 Why care what determines desires for redistribution? Normative relevance If widespread support for a more equal income distribution exists, then redistributive taxation at reasonable cost unambiguously improves social welfare. If redistribution serves the selfish interest of some but not others, we need interpersonal comparability of welfare to make social welfare evaluations. Positive relevance: Understanding to what extent redistribution is due to preferences for equality as opposed to other factors may help identifying the determinants of support for redistributive programs in society, and to understand why the level of redistribution differs significantly among countries.

16 Experimental Design Part 1 “Disinterested Observer” Condition Each participant is asked to choose a tax rate to be applied to the pre-tax earnings distribution among the other 20 participants. At the end of the session one person, the ‘decisive individual’, is randomly selected to determine the actual degree of redistribution. Purpose: Evaluate participants’ redistributive choices when self- interest is absent (or largely so). Keep D.I.’s identity secret. Two or three sets of decisions are made by each subject in each session: The earning of the D.I. is randomly selected from the interval ($19.80 ; $21.80).

17 Experiment Design (Cont.) Part 2. Choice with Personal Stake & Uncertainty The setup is the same as in Exp. 1. However, in this case the base earning of the decisive individual is determined in the same way as those of the other participants. The tax rate chosen by the decisive individual applies to everyone’s earning, including the D.I.’s. Purpose: Analyze participants’ redistributive choices when self- interest but also uncertainty are present (the usual voting situation).

18 Experiment Design (Cont.) Part 3. Choice with Personal Stake, Certainty Subjects get to reconsider their tax choices in Part 2 after learning their exact income rankings. Purpose: Analyze participants’ redistributive choices when self- interest is present and uncertainty is resolved.

19 Pre-tax Earning Distribution The pre-tax earnings of the twenty participants are distributed proportionally to the pre-tax income in the United States in 2000, by 5-percentiles.

20 Pre-tax Earnings Determination How is assignment of subjects pre-tax earnings ranks determined? Four possibilities Randomly Based on home area average income, from ZIP code or country (‘Where From’ [WF]) Based on performance in a game of skill (adapted version of Tetris) Based on performance on a general knowledge Quiz Purpose: Analyze differences in agents’ attitude toward redistribution for different determinants of income inequality (i.e. luck, parental wealth, ability, effort).

21 Taxes and Redistribution Twenty participants’ pre-tax earning (x i ) are taxed at a rate t and the proceedings are equally distributed among all agents. The post-tax pay-off for an affected subject is: y i = (1 - t ) x i +1/20 (1 - e) (∑ i t x i ),  i ≠ i D Efficiency Loss (e) Proportion of the tax revenue lost to redistribution (possible values: 0%, 12.5%; 25%).

22 Tax cost versus efficiency loss Tax cost is charged to the D.I. (dictator) only; it is 0, 25 cents, 50 cents, and 1 dollar per 10% worth of tax, varying across experiment sessions. Tax cost affects the D.I. directly and thus lets us gauge her WTP for more equality. Efficiency loss doesn’t affect the D.I. in Part 1 unless she cares about the sum of others’ earnings (as in Charness-Rabin ’02).

23 Sequence of the Session Part 1 - Instructions Part 1 - Comprehension test Part 1 - Decision stage Part 2 - Instructions Part 2 - Comprehension test Part 2 - Pre decision stage (forecast) Part 2 - Decision stage Quiz Tetris training Tetris game Selection of part paid-off on (Part 1 or Part 2)

24 if Part 2 is selected: Provisional earning summary to each subject Part 3: Tax Revisions possible -Method Determination (Random, WF, Quiz, or Tetris) -Risk aversion test -Decisive individual drawing -Final earnings summary -Exit survey: Background questions Political inclination / ideology Socio-economic status General attitude toward equality and redistribution Sequence of the Session (Cont.)

25 Subject Pool(s) We focus on 16 sessions with 336 Brown University undergraduates (21 per session) studying in every subject area. 55 adult non-student subjects were recruited to 4 other sessions not discussed, but generating similar results.

26 Sessions by Tax Cost and Efficiency Loss # of participants in parenthesis

27 Part 1 ‘Disinterested Observer’

28 Demand for Equality Although self-interested dictators should always select t = 0 when tax cost > 0, more than 75% prefer a positive tax (prefer some redistribution), and even when tax cost = $1 per 10%, 70% prefer some redistribution.

29 Preferences for Equality Prediction: When tax cost > 0 we would expect t = 0 Mean Tax Rate = 41.4 % Mean Tax Rate = 33.7 %

30 Responsiveness to Cost Cross subject comparison shows some responsiveness to tax cost: the higher the cost to the D.I., the less redistribution is demanded.

31 Tax Cost and Willingness to Pay

32 Responsiveness to dead- weight loss Cross subject comparison shows that the larger the fraction of taxed output that is lost to inefficiency/leakage, the smaller the demand for redistribution.

33 Equality-Efficiency Trade-off

34 Demand for redistribution and the source of inequality Within-subject comparisons show that many subjects demand more redistribution when inequalities are “arbitrary” (random and where from methods) than when inequalities are “earned” (quiz and Tetris methods).

35 Tax choices differ significantly across methods.

36 However, the tendency to distinguish between inequalities of different origin is linked to gender: males distinguish strongly, females almost not at all. Most of the difference between male and female tax preferences is due to different preferences under the “earned” methods.

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38 These and other findings are supported by multivariate regressions, including Tobit. Demand for redistribution varies 1.negatively with cost to the D.I. 2.negatively with dead weight loss 3.negatively with “earned” sources of inequality (quiz and Tetris) 4.positively with female gender 5. positively with more liberal political philosophy

39 6. positively with professed preference for equality. 7. negatively with number of economics courses taken. 8. positively with measured risk aversion 9. negatively with family income

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41 The impact of the source of income inequality, and the fact that gender differences are mainly due to different reactions to this, are shown in the following set of regressions.

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43 PART 2 ‘Interested Decision-Maker’

44 Recall that in Part 2, - the D.I.’s tax choice determines the degree of redistribution of the pre-tax earnings of 20 subjects including him/herself. - self-interest dictates choosing high (low) tax if you think you’ll rank near bottom (top) - D.I. has not yet played Tetris or taken the quiz... decision-making under uncertainty - decision in random condition is like Harsanyi’s choice behind ‘ veil of ignorance’

45 - D.I.’s earnings are directly affected by both tax cost and efficiency loss

46 Results in brief -Overall distribution of tax choices is very similar to that in Part 1 -But self-interest contributes importantly to individuals’ choices where they have guesses about their pre-tax income ranks. For Tetris, Quiz, and Where From: ● factors used in Part 1 regressions explain 13% of variance in tax choices ● own expected rank increases explained variance to 31%, hence adds 18% to explained variance (R-Squared).

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48 Interestingly, subjects’ expected own- income ranks for Where From, Quiz, and Tetris incomes also help to predict their Part 1 tax choices—although the addition to explained variance is lower than in Part 2. Since subjects did not even know what the Part 2 treatment would be when making Part 1 choices, the explanation is probably that subjects identify with people like themselves when choosing t (e.g., if I think I’d do badly on Tetris, I’d want the D.I. to select a high tax, so this is what I do as D.I., though it doesn’t affect me personally).

49 In Part 2 like Part 1, males prefer more redistribution under Where From than under Quiz and Tetris, while females prefer similarly high redistribution under all three methods.

50 Figure 11. Part II Average Tax Rate by Method (Females) females males

51 Random Pre-tax Incomes Tax choices under random incomes (“veil of ignorance”) in Part 2 are significantly higher than in Part 1—average 54.6% versus 49.3%—consistent with self- interest and risk-aversion. The next regression studies tax choice with random pre-tax incomes in both Part 1 and Part 2.

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53 The regressions show that being more risk averse and being involving (being in Part 2) raise chosen t, but counter-intuitively the interaction between these two variables is insignificant and doesn’t raise explained variance.

54 Average Part 2 Tax for All 4 Methods

55 Part 3 – involved tax choice with certainty about own rank Included only for the 7 of 16 sessions in which Part 2 (“involved”) payoffs were chosen by coin toss This helps keep D.I.’s identity secret ex post. Thus made by 147 subjects, 588 decisions (t for each of 4 methods x 147).

56 most decisions were fully consistent with self-interest After resolution of uncertainty about own rank, payoff maximization requires selecting t = 0 or t = 100% (depending also on tax cost and dead weight loss) About 66% of decisions were for own payoff maximizing tax rate. There are slightly more deviations from a payoff-maximizing tax of 0 (toward more equality) than from a payoff-maximizing tax of 100% (toward less equality), but the difference is slight.

57 The cost of deviating varies depending on rank For example, for subject with highest pre-tax income, each 10% of redistribution represents a personal sacrifice of about $8 not counting the regular tax cost and any dead weight loss. For subjects near cut-off rank, personal sacrifice is well under $1 per 10% when tax cost is small. ▪ Calculating the individual cost of deviating by rank, factoring in tax cost and dead weight loss, we find deviations negatively related to this cost. (We plan to carry out an integrated analysis of response to tax cost using Part 3 and Part 1 together, hence covering wider range of costs.)

58 We analyze separately decisions of subjects whose income-maximizing tax choice is 0%, then those whose income- maximizing tax choice is 100%. (Observations are by subject-and- method.)

59 Deviations from income- maximizing tax of 0 A quadratic specification with cost of deviation alone can explain 20% of the size of deviations (including 0 deviations). Adding Part 1 tax choice (reflecting pure preference for equality) or explanatory variables including political philosophy can explain an addition 4 to 6% of the variance.

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61 Deviations from income- maximizing tax of 100% This allows expression of preference for inequality under some conditions. The quadratic personal cost specification explains only 0.3% of these deviations. Adding Part 1 tax choice raises R-squared to 4%. Part 1 tax choice is significant at the 1% level in this regression: people who choose lower taxes for the income-determination method in question in Part 1 also choose lower taxes in Part 3—suggesting that they forego some earnings gain in support of their belief about just inequalities (e.g., right to earn more if did better on Quiz).

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63 Provisional Conclusions Most subjects are willing to incur some cost to reduce inequality among others Willingness to pay for equality is sensitive to cost – there’s much less demand for equalization at very high prices Uncertainty and risk-aversion is a major driver of demand for equality Demand for equality is significantly affected by the source of the inequality— earned vs. arbitrary.

64 There are substantial gender effects consistent with the political gender gap in the U.S. The external validity of the experiment is supported by correlations with reported political preferences, and by performance of the non-student sample

65 To be done: More integrated analysis of relative weights on self-interest, risk-aversion, and ‘social preferences’ (values, fairness preferences) in determining tax choices. Calculation of implied voting outcomes and comparison with observed degrees of redistribution in U.S. and other countries. Using an explicit Social Welfare Function to calculate aggregate utility maximizing tax choices.


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