1. Still a Director’s Law? On the Political Economy of Income Redistribution Presentation at the IBL-IREF Conference on ‚Troppe tasse – ma a vantaggio di chi‘, Milan, June 18, 1007
Prof. Dr. Lars P. Feld University Heidelberg, ZEW Mannheim, University of St. Gallen (SIAW-HSG), CREMA Basel and CESifo Munich
Mikan

2. Still a Director’s Law? Outline of the Presentation
Director‘s Law Properly Taken
The Political Economy Rationale
Income Redistribution and Constitutions
Some Descriptive Evidence
Econometric Results
Conclusions
Milan

3. Director‘s Law Properly Taken
Does income redistribution by the state run from rich to poor or from both, rich and poor to the middle income classes?
“Public expenditures are made for the primary benefit of the middle classes, and financed with taxes which are borne in considerable part by the poor and the rich.” (Stigler 1970, p.1)
All public expenditure needs to be considered.
Education, cultural spending and so on.
All public revenue needs to be considered.
A question of budget incidence: Fiscal residuum
Milan

4. The Political Economy Rationale (1)
The median voter model.
Middle classes are always part of the minimum winning coalition.
The simple version already only holds with one dimensional decisions and single peakedness.
Under multi-dimensionality it is always better for the middle income classes to include a poor household than a rich household in the coalition.
Exploitation of the rich.
Director‘s Law proper: The middle and the poor coalesce against the rich.
Milan

5. The Political Economy Rationale (2)
Meltzer and Richard (1981)
The higher the gap between mean and median income, the more redistribution is undertaken.
Increase in skewness towards high income earners.
Romer-Roberts
Regressive taxation, if the median income taxpayer is sufficiently productive.
Limits of redistribution as taxpayers avoid taxation and transfers pose adverse incentives.
Milan

6. The Political Economy Rationale (3)
Political participation and voter turnout
High income earners participate more in politics.
Private provision of public goods
Potentially also a coalition of rich and poor against the middle classes.
Non-linear taxes
Rich and the middle classes against the poor.
Voluntary income redistribution
More important within social or ethnic groups.
But also: Targeted spending.
Milan

7. The Political Economy Rationale (4)
Poorly informed voters and probabilistic voting
Pork-barrel politics as a different kind of targeting.
Special interest politics.
Difficult to predict a Director‘s Law.
Ideology may induce a Director’s Law
The economic interests of the rich and the poor are closely entangled with their ideologies.
The middle classes are politically much more mobile and will benefit from electoral platforms framed in their interests.
Milan

8. Income Redistribution and Constitutions (1)
Direct vs. Representative Democracy
Political decision are more in line with median voter interests.
Speaks for validity of Director‘s Law in direct democracy.
But: Issue unbundling via citizen intiatives.
Like in the private provision of public goods, more targeted spending.
Less redistribution towards the middle income classes.
Milan

9. Income Redistribution and Constitutions (2)
Presidential vs. Parliamentarian Systems
Head of parliamentary regime has additional bargaining power vis-à-vis the legislature.
Confidence vote and career concerns.
Presidents at times of divided government need to ensure a broad majority in the legislature.
Representatives from different electoral districts are in charge of agenda-setting in committees on taxing and spending.
More targeted spending and lower taxes in presidential systems.
Milan

10. Income Redistribution and Constitutions (3)
Plurality rule vs. Proportional Representation
Spending targeted to districts under plurality rule
Proportional representation is associated with multi-party parliaments and the need to form coalition governments with more or less diverse interests.
A government needs to win the support of 50% plus one voter – it needs to rest on a wider basis than in the case of plurality rule.
Broader expenditure programs and in the case of income redistribution more general transfer schemes under proportional representation.
Milan

11. Income Redistribution and Constitutions (4)
Federalism vs. Unitarianism
Who migrates in competitive federalism?
If it is the middle classes, Director‘s Law obtains.
If it is the high income earners, Director‘s Law is restricted.
Summarizing hypotheses
Direct democracy: Theoretically open.
Presidential systems and plurality rule: more difficult to realize Director‘s Law.
Competitive federalism: Mobile high income earners restrict Director‘s Law.
Milan

12. Some Descriptive Evidence (1)
Table 2: Income Distribution and Redistribution according to Gini-Coefficients, OECD Countries, 2000
Gini coefficients
Redistribution from
Relative importance of transfer types
Country
Market
Disposable
Difference
Taxes
Transfers
Pensions
Unemployment Benefits
Others
Belgium
0.465
0.242
0.223
0.062
0.161
0.107
0.023
0.030
Sweden
0.441
0.218
0.038
0.180
0.019
0.055
Netherlands
0.458
0.257
0.202
0.041
0.160
0.088
0.011
Finland
0.417
0.194
0.048
0.146
0.087
0.016
0.044
France
0.469
0.292
0.177
0.021
0.157
0.099
0.018
0.039
Denmark
0.412
0.245
0.167
0.036
0.131
0.024
0.052
Germany
0.421
0.254
0.047
0.119
0.089
0.006 UK
0.475
0.323
0.153
0.031
0.121
0.005
0.073
Norway
0.379
0.235
0.144
0.040
0.104
0.065
0.043
Australia
0.423
0.297
0.126
0.049
0.077
Canada
0.406
0.290
0.116
0.078
0.037
Switzerland
0.395
0.293
0.102
0.009
0.093
0.013
0.001
USA
0.447
0.345
0.046
0.056
0.033
0.002
Mean
0.431
0.271
0.122
0.071
Source: Luxembourg Income Study, 2004.

13. Some Descriptive Evidence (2)
Table 3: Poverty Measures and Poverty Reduction in Selected OECD Countries in 2000
Poverty measure
Poverty reduction
Country
Market incomes
Disposable incomes
Belgium
27.7
4.1
23.6
Netherlands
26.7
4.5
22.3
Sweden
25.7
4.4
21.3
Finland
22.2
3.2
19.0
Denmark
24.1
5.6
18.5 UK
25.4
7.3
18.0
France
22.7
5.3
17.4
Germany
21.5
17.1
Norway
19.3
4.0
15.3
Australia
8.0
13.3
Switzerland
17.2
5.5
11.8
Canada
19.1
7.6
11.5
USA
20.1
11.6
8.5
Mean
22.5
5.8
16.7

14. Some Descriptive Evidence (3)
No clear-cut results from the descriptive data
Early evidence from the 1970‘s on budget incidence supporting Director‘s Law.
But: Strong assumptions as to the incidence of particular spending categories.
Evidence supporting Meltzer-Richard.
Democracy leads to more redistribution.
Plurality rule leads to less welfare spending.
Presidential systems have less welfare spending.
Milan

15. Econometric Results (1)
Table 4: Cross Country Regressions of the Gini-Index on Electoral Systems and Forms of Government, OLS, 70 Countries, Averages for the Period 1990 to 1998
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
Log Income
3.067**
[2.29]
3.262**
[2.45]
3.556**
[2,0]
4.033**
[2.30]
3.708*
[1.99]
3.901**
[2.05]
4.191**
[2.18]
4.529**
[2.17]
Enrolment in Primary and Secondary Education
0.185***
[2.64]
0.171**
0.169**
[2.36]
0.204***
[2.77]
0.210***
[2.81]
0.225***
[2.84]
0.217***
[2.73]
0.218***
[2.71]
Log Population
0.043
[0.08]
-0.071
[-0.13]
-0.118
[-0.19]
0.633
[0.11]
-0.006
[-0.01]
-0.136
[-0.21]
-0.627
[-0.76]
-0.562
[-0.67]
Proportion of Population of Age 15 to 64 Years
-0.589**
[-2.21]
-0.498*
[-1.85]
-0.523*
[-1.79]
-0.269
[-0.94]
-0.271
[-0.93]
-0.316
[-1.05]
-0.218
[-0.69]
-0.237
[-0.73]
Proportion of Population above 64 Years
-1.837***
[-6.34]
-1.733***
[-5.79]
-1.754***
[-5.40]
-1.964***
[-5.23]
-1.987***
[-5.22]
-1.880***
[-4.47]
-1.869***
[-4.44]
-1.848***
[-4.33]
Presidential Regimes –
3.522*
[1.69]
3.635
[1.60]
4.816**
[2.08]
4.696**
[2.00]
4.637*
[1.97]
4.573*
[1.94]
4.916*
[1.96]
Plurality Rule
-0.408
[-0.24]
-0.538
[-0.29]
-0.719
[-0.39]
-0.369
[-0.06]
-0.084
[-0.04]
0.040
[0.02]
Federal Political Structure
0.226
-0.622
[-0.25]
-0.368
[-0.14]
-0.186
[-0.07]
-0.135
[-0.05]
-0.169
[0.06]

16. Econometric Results (2)
Central Government Expenditure as a Percentage of GDP –
-0.013
[0.05]
0.002
[0.01]
0.005
[0.02]
-0.091
[-0.34]
-0.092
[-0.35]
Central Government Revenue as a Percentage of GDP
0.039
[0.18]
0.024
[0.11]
0.015
[0.07]
0.139
[0.55]
0.137
[0.54]
Ethnolinguistic Fractionalization
-2.201
[-0.55
-3.072
[-0.71]
-1.890
[-0.42]
-1.393
[-0.30]
Gastil Index of Civil Liberties and Political Rights
0.756
[0.61]
1.352
[0.98]
1.157
[0.79]
Trade Openness (Exports plus Imports of Goods and Services Divided by GDP)
-0.295
[-0.99]
-0.028
[-0.93]
Age of Democracy
-2.190
[-0.43]
Constant
49.197
41.334
40.876
17.938
21.071
18.814
12.006
10.588
Obs. 70 68 63
Adj. R2
0.595
0.603
0.581
0.617
0.612
0.607
0.602
F-statistics
21.28
15.95
12.61
10.99
9.89
8.98
8.36
7.65
RMSE
6.633
6.571
6.712
6.085
6.127
6.165
6.166
6.218

17. Econometric Results (3)
Table 5: Panel Regressions of the Gini-Index of Primary Income Distribution on Fiscal Decentralization, Pooled Regressions with Time Fixed Effects, 13 OECD Countries, 1981 to 1998
(1)
(2)
(3)
(4)
(5)
(6)
(7)
GDP per Employee
0.001***
[3.21]
[3.42]
[4.05]
[3.94]
[3.84]
[4.37]
[4.27]
Government Edu-­cation Spending
-0.004**
[-2.40]
-0.001
[-0.21]
-0.002
[-1.34]
[-1.33]
0.000
[0.18]
[-0.91]
[-0.87]
Population Growth in Percent
[-1.50]
[-0.84]
-0.000
[-0.54]
[-0.64]
[-1.06]
[-0.76]
[-0.89]
Expenditure Decentralization –
-0.001***
[-5.63
[-4.96]
[-6.47]
[-5.70]
[-5.79]
Revenue Decentra­lization (tax rates and bases)
[-4.60]
[-1.08]
[-1.04]
[-4.64]
[-1.30]
[-1.27]
Revenue Decentra­lization (tax rates and bases or joint taxation)
[-3.51]
0.001
[1.19]
[-3.19]
0.002
[1.52]
Revenue Decentra­lization (tax rates and bases, joint taxation or fiscal equalization)
-0.002*
[-1.70]
-0.002**
[-2.00]
Openness
-0.195***
[-3.15]
-0.171***
[-2.80]
-0.182***
[-2.99]
Constant
0.395
0.428
0.432
0.435
0.439
0.441
0.445
Adj. R2
0.177
0.484
0.509
0.513
0.503
0.523
0.530
SER
0.032
0.026
0.025
0.024
F-statistic
3.517
11.016
11.606
11.353
11.391
11.796
11.650
For Notes see Table 4.

18. Econometric Results (4)
Table 6: Panel Regressions of the Gini-Index of Disposable Income Distribution on Fiscal Decentralization, Pooled Regressions with Time Fixed Effects, 13 OECD Countries, 1981 to 1998
(1)
(2)
(3)
(4)
(5)
(6)
(7)
GDP per Employee
0.002***
[3.86]
[4.71]
0.003***
[6.92]
[6.87]
[6.88]
[9.58]
[10.05]
Government Edu-cation Spending
-0.011***
[-5.50]
-0.013***
[-6.71]
-0.018***
[-10.28]
[-10.65]
[-6.82]
-0.016***
[-10.87]
-0.015***
[-11.76]
Population Growth in Percent
0.001 [0.80]
0.000 [0.12]
0.001
[0.95]
[0.74]
-0.001
[-0.54]
0.000
[0.33]
-0.000
[-0.07]
Expenditure Decentralization –
0.001***
[4.47]
[7.17]
[1.60]
[4.04]
[4.26]
Revenue Decentra­lization (tax rates or bases)
[0.57]
[6.55]
[6.91]
[0.83]
[7.28]
[8.09]
Revenue Decentra­lization (tax rates or bases or joint taxation)
-0.002***
[-8.94]
0.004***
[2.94]
-0.001***
[-9.63]
0.005***
[5.15]
Revenue Decentra­lization (tax rates or bases, joint taxation or fiscal equalization)
-0.006***
[-4.29]
-0.007***
Openness
-0.708***
[-10.22]
-0.639***
-0.672***
[-12.47]
Constant
0.253
0.216
0.226
0.235
0.259
0.272
Adj. R2
0.169
0.282
0.470
0.508
0.510
0.653
0.711
SER
0.037
0.034
0.029
0.028
0.280
0.024
0.022
F-statistic
3.378
5.208
10.081
11.171
11.655
19.513
24.226
For Notes see Table 4.

19. Econometric Results (5)
Table 7: Panel Regressions of Fiscal Redistribution Measured in Gini-Points on Fiscal Decentralization without Controlling for the Primary Income Distribution, Pooled Regressions with Time Fixed Effects, 13 OECD Countries, 1981 to 1998
(1)
(2)
(3)
(4)
(5)
(6)
(7)
GDP per Employee
-0.000
[-0.83]
-0.001**
[-2.40]
-0.001***
[-3.61]
[-3.45]
[-3.60]
-0.002***
[-4.74]
[-4.65]
Government Education Spending
0.007***
[2.75]
0.013***
[7.36]
0.016***
[9.52]
[9.65]
0.011***
[7.27]
0.014***
[9.35]
[9.57]
Population Growth in Percent
-0.003*
[-1.73]
-0.001
[-0.84]
[-1.47]
[-1.33]
[-0.43]
[-1.05]
Expenditure Decentralization –
[-9.78]
[-11.58]
[-11.79]
[-7.70]
[-9.40]
[-9.61]
Revenue Decentra­lization (tax rates or bases)
[-4.52]
[-7.78]
[-7.97]
[-5.18]
[-8.12]
[-8.46]
Revenue Decentra­lization (tax rates or bases or joint taxation)
0.001***
[6.18]
-0.002*
[-1.93]
[5.94]
-0.003***
[-3.05]
Revenue Decentra­lization (tax rates or bases, joint taxation or fiscal equalization)
0.004***
[2.84]
[3.95]
Openness
0.513***
[7.71]
0.467***
[7.49]
0.489***
[8.07]
Constant
0.143
0.213
0.206
0.020
0.185
0.182
0.173
Adj. R2
0.100
0.547
0.612
0.624
0.641
0.689
0.709
SER
0.045
0.030
0.028
0.027
0.025
0.024
F-statistic
1.018
13.932
17.176
17.338
19.329
22.828
24.005
For Notes see Table 4.

20. Econometric Results (6)
Table 8: Panel Regressions of Fiscal Redistribution Measured in Gini-Points on Fiscal Decentralization Controlling for the Primary Income Distribution, Pooled Regressions with Time Fixed Effects, 13 OECD Countries, 1981 to 1998
(1)
(2)
(3)
(4)
(5)
(6)
(7)
GDP per Employee
-0.002***
[-3.33]
-0.001***
[-3.35]
[-5.47]
[-5.49]
[-5.54]
[-8.16]
[-8.74]
Government Education Spending
0.010***
[5.12]
0.013**
[7.68]
0.017***
[10.88]
[11.24]
0.011***
[7.90]
0.015***
[11.71]
[12.66]
Population Growth in Percent
-0.001
[-1.03]
[-0.64]
[-1.36]
[-1.16]
0.000
[0.017]
[-0.76]
-0.000
[-0.36]
Gini Index of Primary Income Distribution
0.828***
[11.08]
0.319***
[4.16]
0.446***
[6.43]
0.476***
[7.04]
0.450***
[6.86]
0.559***
[9.70]
0.605***
[11.32]
Expenditure Decentraliza-­ tion –
[-8.01]
[-9.92]
[-10.12]
[-5.03]
[-7.00]
[-7.13]
Revenue Decentra­lization (tax rates or bases)
[-3.25]
[-7.97]
[-8.29]
-0.000***
[-3.40]
[-8.80]
[-9.62]
Revenue Decentra­lization (tax rates or bases or joint taxation)
0.001***
[8.02]
-0.003***
[-2.69]
[8.96]
-0.004***
[-4.97]
Revenue Decentra­lization (tax rates or bases, joint taxation or fiscal equalization)
0.005***
[3.92]
0.006***
Openness
0.601***
[9.71]
0.563***
[10.57]
0.599***
[12.17]
Constant
-0.185
0.076
0.013
-0.008
-0.012
-0.064
-0.096
Adj. R2
0.352
0.578
0.672
0.692
0.703
0.781
0.815
SER
0.036
0.029
0.026
0.025
0.0245
0.021
0.019
F-statistic
7.073
15.053
21.144
22.245
24.292
34.816
41.214
For Notes see Table 4.

21. Econometric Results (7)
Table 9: Swiss Cantonal and Local Expenditure, Revenue, Taxes, and Welfare Expenditure per Capita, 1980 – 1998, 494 Observations
(1)
(2)
(3)
(4)
Public Expenditure
Public Revenue
Tax Revenue
Welfare Expenditure
Direct democracy
-0.034*
-0.033*
-0.041***
-0.165***
(2.17)
(2.34)
(3.33)
(6.89)
Fiscal decentralization
-1.110***
-0.942***
0.041
-0.489
(3.74)
(3.47)
(0.21)
(1.10)
Tax competition
-0.074
-0.107*
-0.209***
-0.082
(1.36)
(2.15)
(7.00)
(1.01)
Fiscal constraints
-0.019(*)
-0.007
0.011*
-0.050***
(1.74)
(0.75)
(2.06)
(3.51)

22. Econometric Results (8)
Table 10: Inequality and Redistribution in Swiss Cantons, 1981 – 1997, 208 Observations (Gini-Coefficients in Percentage Points)
(1)
(2)
(3)
(4)
Pre-Tax Gini-Coefficient
Post-Tax Gini-Coefficient
Difference
Pre-Tax Gini-Coefficient
0.073***
(6.62)
Direct democracy
-1.780***
-1.647**
-0.133***
-0.004
(6.64)
(6.66)
(5.96)
(0.19)
Fiscal decentralization
-4.983
-4.43
-0.524
-0.131
(0.86)
(0.83)
(1.10)
(1.02)
Tax competition
1.702(*)
1.558(*)
0.141*
0.013
(1.94)
(1.93)
(1.98)
(0.43)
Fiscal constraints
-0.551**
-0.503***
-0.048**
-0.007
(3.05)
(3.02)
(3.19)
(0.89)

23. Econometric Results (9)
Table 11: Inequality and Redistribution, 1992, 4178 Observations
(1)
(2)
(3)
(4a)
(4b)
Pre-Tax Household Income
Post-Tax Household Income
Difference
Difference (predicted gross income)
Difference (original gross income)
10th quantile
(0.39)
(0.65) *
(2.55) **
(2.84) **
(2.65)
20th quantile
(0.97)
(0.91) **
(2.62) *
(2.27)
***
(3.64)
30th quantile
(1.57)
(0.62) **
(2.76) *
(2.24)
***
(4.35)
50th quantile
(0.86)
(1.20) *
(2.42)
(0.58)
(0.55)
70th quantile
(0.38)
(0.25) **
(2.68)
(1.35)
(0.88)
80th quantile
(0.81)
(0.08)
***
(3.19) *
(2.52)
(0.79)
90th quantile
(0.87)
(0.44) *
(2.47)
(1.50)
(0.13)

24. Conclusions Does redistribution follow a Director’s Law?
Arguments from the political economy of income redistribution do not allow to draw that conclusion: Too diverse arguments.
Descriptive evidence: also ambiguous.
Evidence on budget incidence: Not reliable.
Presidential systems: less welfare spending and more unequal distribution of disposable income.
Plurality systems: less welfare spending, but no significant effect on income distribution.
Milan

25. Occurrence of Director‘s Law depends on the political system in place.
Conclusions
Direct democracy:
lower welfare spending
lower broad-based taxes
less income redistribution only when primary income distribution not too unequal.
Fiscal competition:
Restrictions on Director‘s Law
Occurrence of Director‘s Law depends on the political system in place.
Milan