Opening lecture on Inequality and taxation: economic theory and policy implications

Another year has started, and with it a new generation of TSE students has arrived to Toulouse from mid-August. To celebrate the new school year, the administration had its usual welcome talks and lunch on September 11th. Following the tradition, there was an opening lecture at the end of the day. This year, Nicolas Werquin, an assistant professor at TSE, was in charge of the lecture.

Professor Werquin started his lecture by explaining how inequality is measured using top income shares. He explained how this method of collecting tax returns is not the best one, given that it only includes taxable income, ignoring the different transfers that households might receive. Next, he presented data about wealth, dividing it into 3 different groups: 1%, 1-5%, and 5-10% of the wealthiest people in the USA. Focusing on the top 1%, this group was the most affected by the Great Depression, because of their capital intensive wealth. Now, it is almost halved between capital and labour.

Moving to the models, he started with a brief description of the Mirrlees model with the key assumption that labour supply or earnings are endogenous to taxes, which will result in a trade-off between equity and efficiency. In this case, a concern rises about the elasticity of the labour supply with respect to the marginal tax rate. In other words, people will tend to work less when you tax them on wages.

Next, he presented how inequality is rising given the differences between a college and a high school degree. The wage premium has increased across time, passing from below 0.5 between 1940 and 1970, to 0.7 by 2008. This difference is mainly due to the increasing demand of high-skill labour that we can observe in several markets in which technology and services are dominant.

Using a more formal way to explain this, Professor Werquin used a canonical model, where wage premium is determined by the relative supply and relative demand of skills. The key is that high and low skills are imperfect substitutes.

With this, professor Werquin presented his last model: a general equilibrium Mirrleesian model, which combines the two previously mentioned models (Mirrlees and the imperfect substitutability of skills in production). With this model, he obtains interesting results. For example, a marginal tax rate impacts labour supplies through wages in different ways: a decrease in the marginal productivity of labour of a certain type of agents makes them work more, reduces their wages, and, given the relation between the labour with respect to their skill, this makes all the other types adjust their wage to the lowest.

To finish his presentation, he proposed that it is necessary to design a reform of the tax transfer system that offsets the welfare losses induced by the disruption, by redistributing the gains of the winners. However, difficulty arises due to combination of distortionary taxes plus general equilibrium. For example, lowering marginal taxes generates further welfare effects that need to be corrected by other distortionary taxes.

Finally, he encouraged students to work in Public Economics given that the strong tradition of this field was initiated by the founder of the Toulouse School of Economics, Jean-Jacques Laffont.

By José Alfonso Muñoz Alvarado

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