A radical proposal to fight poverty in the developing world: tax the rich more than the poor

The world’s poorest people have been getting richer recently, but they remain incredibly poor, with 10 percent of the world’s population still consuming $1.90 or less a day — a small fraction of the resources available to people at the US poverty line.

Here is a radical proposal that could improve their lot: progressive taxation and welfare systems.

That may seem so obvious as to not be worth mentioning. In the developed world, government taxes together with transfer systems like welfare payments are readily accepted as one way reduce the gap between the rich and the poor. That’s true even in the United States, where laissez-faire is a state religion.

But new data on taxation and spending in the world’s poorest countries suggests that progressive tax-and-transfer systems are far less common than you would think. In general, taxes are less progressive in those countries, financial transfers are much smaller, and the bulk of social spending is soaked up by broken health and education systems. The net effect is often that tax-and-transfer policies leave poor people worse off, not better.

Tax and transfer systems reduce inequality in the rich world but can exacerbate poverty in the poorest countries

In the OECD club of rich countries, taxes and transfers reduce overall income inequality by about 25 percent on average, according to a study by OECD economists Isabelle Joumard, Mauro Pisu, and Debbie Bloch.

That happens in two ways: The income of the well-off is reduced by higher taxes (this accounts for about a quarter of the reduction in inequality) while the poor get payments like Social Security as well as family, housing, disability and unemployment benefits. The latter accounts for three-quarters of the reduction in inequality. The US is an outlier in seeing less redistribution than most rich countries, but even there, the net impact of taxes and transfers is to reduce inequality.

But only recently has data made clear just how limited the impact of government redistribution in many developing countries is. That finding emerged in a series of studies by the economist Nora Lustig and colleagues at the Commitment to Equity Institute at Tulane University.

The Gini coefficient measures the level of inequality in a group: A measure of 0 implies complete equality (everyone gets the same income) and 100 is perfect inequality (one person gets all of the income). Before government taxes and transfers, the Gini for the 29 developing countries in Lustig’s study is 47. (It stands at 45 in the United States). Fiscal redistribution reduces the Gini coefficient by more than 7 points in the US and European Union.

In contrast, fiscal redistribution reduces the Gini by a mere 2.6 points on average in developing countries.

In the rich world, the poorest citizens tend to be net financial recipients from the government — they get more in transfers than they pay in taxes. But that’s not true in some developing countries. First, tax regimes in those countries aren’t very progressive, partly because the revenue authorities tend to rely on indirect taxes like the value-added tax (VAT) — which fall on all consumers — rather than direct taxes on high personal or corporate incomes. (A VAT is similar to an American sales tax but applies to all firms, not just retail businesses.)

The mechanics of a VAT are easier to implement for a weak state because the tax is collected from registered businesses — millions of individuals don’t have to file tax returns. And so organizations like the International Monetary Fund have pushed countries down this path, prioritizing the need for revenue over a concern for equity. At the same time, welfare programs that transfer more cash to the poorest citizens tend to represent a far smaller part of government spending in developing countries, relative to their richer peers.

If their tax rates are similar, by definition that means poor people in these nations on net lose a similar proportion of their income to the government as do rich people. And that means, in turn, that the impact of government can be to increase poverty rates. In four of the five sub-Saharan African countries for which the Tulane center provides data, the net effect of taxes and transfers is to increase the number of people living below the World Bank’s extreme poverty line ($1.25 of purchasing power per person per day).

In Tanzania, poverty is nearly 20 percent higher due to taxes and transfers, they found. For comparison, the proportion of people consuming below the US poverty line (around $15 per day) is reduced from 29 to 16 percent thanks to taxes and transfers, according to a study by Columbia University’s Christopher Wimer and colleagues.

The picture is more positive in Latin America where (richer) governments have focused on reducing inequality through more significant transfer programs. Data from the Tulane Institute shows that in Chile and Argentina, taxes and transfers reduce extreme poverty by about two-thirds (although, to be sure, those countries start with a far lower level of poverty than Tanzania). In Brazil, taxes and transfers reduce the number of extreme poor on the World Bank’s definition by about one-third. These fiscal efforts are still modest by OECD standards but have contributed to a broad decline in inequality in the region since 2000.

To caricature a bit, rich countries give poor people money while poor countries give them schools with no teachers

Developing countries are stingy with cash transfers, but poor people in those countries do get services from government spending, including roads, security, health, and education. The two largest in-kind benefits that developing country governments provide are free or subsidized education and health care. The 29 low- and middle-income governments Lustig and colleagues study spend 4.3 percent of GDP on education and 3 percent on health. While that’s smaller than the OECD average of 5.3 percent on education and 6.2 percent on health, it is still a considerable outlay.

But it isn’t clear who benefits most from that expenditure. In education, for example, the average government teacher in Tanzania is paid almost four times GDP per capita to teach. In Kenya, teachers are paid about five times GDP per capita. That compares to average teacher pay in the US of about $59,000 a year, which is roughly equal to GDP per capita.

In East Africa, teacher salaries account for the considerable majority of education spending. But despite that, they don’t show up for work: Public school teachers in Tanzania and Kenya are absent from class 47 percent of the time, according to World Bank data. And many fail simple ability tests — the average teacher score on test questions involving the addition of two decimals was only 64 percent in Tanzania, for example. Poor-quality teaching is one obvious reason student learning outcomes are so grim, as tests have repeatedly shown.

The point here is not to scapegoat teachers or doctors and nurses. The failure of health and education systems in poor countries has complex causes. The point is that poor people in poor countries pay almost as large a proportion of their incomes as richer people do to the government. In return, they get anemic transfers — plus government services that are often of low quality.

Look at the graph above, which ranks countries from richest to poorest: There is a fairly clear pattern by which the poorest countries spend the lowest percentage of GDP on social services. And they spend less on cash transfers (for example, direct transfers or pensions) as opposed to in-kind services like health and education.

There is some irony here. Where people are poorest, social spending as a whole — including education, health, and welfare payments — is lowest as a share of GDP. And where public services are the least reliable, the proportion of social spending devoted to precisely those unreliable public services is highest.

Ultimately, eradicating global poverty will require decades of sustained economic growth, and a state capable of delivering high-quality education and health services to all. Countless government officials are working toward those goals.

But in the short term, just making the current system of taxes and transfers slightly more progressive would be — on a technical level, if not a political one — a pretty easy fix for poverty and inequality in many countries.

As this new data shows, it’s not that simple redistribution doesn’t work. It’s that in the poorest parts of the world, it hasn’t been tried.

Charles Kenny is a senior fellow and the director of technology and development at the Center for Global Development. Justin Sandefur is a senior fellow at the center. They thank Divyanshi Wadhwa for excellent research assistance and Nora Lustig for helpful clarifications.

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