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Analytical Studies Branch Research Paper Series
Income Inequality and Redistribution in Canada: 1976 to 2004
Income Inequality and Redistribution in Canada: 1976 to 2004
by Andrew Heisz
After remaining stable across the late 1970s and 1980s, family after-tax-income inequality rose during the 1990s. This increase occurred at the same time as a reduction in the generosity of several income transfer programs, including the Employment Insurance and Social Assistance Programs (in some provinces), and decreases in income tax rates. This potentially reflects a weakening of the redistributive role of the Canadian state.
However, while rising after-tax-income inequality can result from a weakening redistribution system, it can also result from rising inequality in family market (pre-tax, pre-transfer) income. In this report we address the following question: Is income redistribution playing a smaller equalizing role in recent years than it did in the past, or is increasing inequality being driven by rising familiy market-income inequality?
We document trends in family after-tax-income inequality since 1976 using updated survey data covering all Canadians. We also examine how income redistribution through the tax-transfer system affects the level and growth rate of after-tax inequality, and ask if this has changed in recent years.
When examining the income of families, it is important to account for family size. In this study, before any other computations are made, family income is adjusted for family size using the widely accepted method of assigning each person in the family an amount of income equal to the square root of the total family income. This compensates for economies of scale present in larger families and yields indicators that reflect family income defined on a per-person basis. Therefore, any reference to income in this study refers to 'adjusted family income per person' unless otherwise noted.
It is also important to compare results to those from other datasets. We compare our results to census and income-tax data and these yield similar conclusions.
We examine inequality and redistribution using several well-known scales and widely accepted methods. For the purposes of this summary, we focus on levels and trends in the following indices:
While the latter two indicators do not measure inequality, they allow us to focus on what is happening in the middle and bottom of the family income distributions respectively.
Trends in after-tax-income inequality
Values of these indicators are shown in Table A for 2004. Also, for comparative purposes, we show values for 1979 and 1989. These years, which are near to business cycle peaks are, good points of comparison to evaluate trends.
Table A Trends in after-tax-income inequality, 1979 to 2004
The results show that family income became more equally distributed across the 1980s. The ratio of after-tax income of the top 10% to the bottom 10% fell from 7.46 in 1979 to 6.58 in 1989, and the Gini also fell. However, from 1989 to 2004, income inequality rose. The ratio of after-tax income of the top 10% to the bottom 10% rose from 6.58 in 1989 to 8.85 in 2004 (up by 35%), and the Gini also rose. The results indicate that after-tax-income inequality was higher in the post-2000 period than at any other point since 1976.
A close examination of after-tax income reveals that from 1989 to 2004, income fell for lower-income families but grew for middle- and higher-income families. Average income in the bottom 10% fell by 8% over this period, but rose by 8% at the median and by 24% in the top 10%. As a result, the absolute range between those with income in the bottom 10% and those in the top 10% also rose. In real dollars, after-tax income for a four-person family1 was stable at about $110,000 higher in the top decile compared to the bottom decile all through the 1976-to-1995 period, but grew thereafter, reaching $147,600 by 2004. This indicates that the increase in after-tax-income inequality is of significant absolute magnitude as well as relative magnitude.
Income polarization also rose over the 1990s. The share of Canadians with family after-tax income from 75% to 150% of the median after-tax income fell from 52.1% in 1989 to 47.3% in 2004, a drop of 4.8 percentage points. Closer inspection of the data reveals that the trend away from the middle class (defined by income) was both towards lower-income and higher-income persons. The share of persons with after-tax income below 75% of the median rose by 2.6 percentage points, while that share with income above 150% of the median rose by 2.0 percentage points.
The share of persons with adjusted income below one half of the 1979 level of adjusted family median income fell across the 1980s but rose in the 1990s, ending at 10.2% in 2004, which is slightly higher than it was in 1989.
Trends in income redistribution
Is the increase in inequality described above the result of income redistribution playing a smaller equalizing role in recent years than it did in the past, or is increasing inequality being driven by other sources? (For the purposes of this summary, we only examine the effect of redistribution on inequality, but note that the effect was similar on other indicators we examined.)
There are several reasons to suspect that the role of the tax-transfer system in equalizing incomes may be different in the 2000s than in earlier decades. While the paper does not go in to these in great detail, we note that changes in social assistance and employment insurance eligibility and entitlement levels (these generally became more generous across the 1980s and then less across the 1990s), the introduction of new programs such as the Canada Child Tax Benefit and the Goods and Services Tax credit, as well as the maturation of the Canada Pension Plan and the Québec Pension Plan were important developments which may have affected the amount of income redistribution that is done through the transfer system. Moreover, increases in real tax rates across the 1980s, followed by their reduction in the 1990s, may have had implications for redistribution through the tax system.2
To understand how much of a role redistribution is playing in the 2000s relative to earlier decades, we start by examining family market-income inequality (market income includes wages, salaries, self-employment income, investment income, private pensions and other 'market-based sources'). Then we ask how the state redistributes income through income transfers (such as the Canada Pension Plan and the Québec Pension Plan, employment insurance, social assistance, Workers' Compensation, the Canada Child Tax Benefit, the Goods and Services Tax credit, and other direct government transfers) and taxes (federal and provincial income taxes), thereby reducing market-income inequality. The difference between inequality in family market income and inequality in family after-tax income is an indicator of how much the state redistributes family income and reduces income inequality.3
Moreover, there are two ways to think about the impact of redistribution on inequality. One is to ask how redistribution has affected the level of inequality. The second is to ask what role redistribution has played in inequality growth. Both of these perspectives can be observed by looking at Table B.
We begin by examining the effect of redistribution on the level of inequality. In 2004, the Gini index based on family market income was 0.428 while on family after-tax income it was 0.315, meaning that the direct effect of redistribution was to reduce inequality (as measured by the Gini) by 0.113. In 1989, redistribution lowered income inequality by 0.104, and in 1979, redistribution lowered inequality by 0.078. Thus, redistribution lowered inequality by more in 2004 than it did in either 1989 or 1979. The study shows that changes in transfers and taxes together contributed to the rise in redistribution across the 1980s. During the 1990s, our results show that the changes in taxes and transfers described above had little net effect on overall redistribution, which remained as strong in 2004 as it was in 1989.
Table B Trends in income redistribution, 1979 to 2004
As noted before, another perspective is to ask what role redistribution has played in inequality growth. Again, to understand this, it is useful to first look at developments in family market-income inequality. The Gini for family market-income inequality rose from 0.361 in 1979 to 0.381 in 1989 (up 0.020) and then rose faster across the 1990s, reaching 0.428 by 2004 (up 0.047). In 1989, redistribution reduced the Gini by 0.026 more that it did in 1979, more than offsetting the rise in market-income inequality in that decade. Hence, family after-tax-income inequality fell across the 1980s. By 2004, redistribution reduced the Gini by only 0.009 more than in 1989, so the lion’s share of the increase in market-income inequality from 1989 to 2004 was converted to an increase in after-tax-income inequality.
Said differently, redistribution grew enough in the 1980s to offset 130% of the growth in family market-income inequality — more than enough to keep after-tax income inequality stable. However, in the 1990-to-2004 period, redistribution did not grow at the same pace as market-income inequality and offset only 19% of the increase in family market-income inequality. To get a scale of redistribution necessary to stabilize income, we note that, other things equal, redistribution would have needed to expand enough to reduce the Gini by more than twice as much in the 1990s as it did in the 1980s in order to prevent after-tax income inequality from rising in that decade.
It is difficult to conclude exactly how changes in particular tax or transfer programs may have contributed to these results from the analysis presented in this paper. However, we can make three general conclusions:
While this study does not investigate why family market-income inequality rose, one factor which likely plays a role in this is a widening inequality in family earnings (from wages, salaries and net self-employment income). A key driver of this is the rising earning power of the two-earner family, especially when both earners are highly educated. (Preliminary results suggest that individual earnings inequality is not driving this trend.) The report also notes that market income has fallen significantly at the bottom of the income distribution: average family market income in the bottom decile fell by 18.7% from 1979 to 1989 and by a further 10.7% from 1989 to 2004. This suggests that low earnings and unemployment may also be playing a role. This may be particularly important among lone-parent families and unattached individuals who are more vulnerable to interruptions in employment.
This study shows that, after remaining stable for several decades, family after-tax-income inequality rose in the 1990s, settling at a higher level in the 2000s. At the same time, the share of middle-income families was reduced and the share of low- and high-income families grew larger. The absolute gap between bottom- and top-income families also increased in a substantive way, indicating that these increases in inequality have an important magnitude. These trends appear to have been driven by rising inequalities in income received from market sources (wages, salaries, self-employment income, private pensions and investment income) among families.
Many industrialized countries experienced an increase in after-tax-income inequality across the 1990s. For example, in the United States, after-tax-income inequality rose by 0.033 from 1986 to 2000, which is a slightly larger increase than the one that was observed in Canada over the same period. Moreover, similarly to Canada, the increase in United States after-tax-income inequality was driven by an increase in market-income inequality, and not a reduction in redistribution. After-tax-income inequality also rose in Finland, Germany, Norway, Sweden, and the United Kingdom over a similar period (Mahler and Jesuit, 2005). This suggests that, in part, an explanation common to many countries might be sought to understanding the rise in inequality, although this does not rule out country-specific causes as well.
Trends in income inequality are certainly something we should continue to monitor. Presently, Canada has a level of family market-income inequality that sits near the middle level of the market-income inequality of Western countries (Mahler and Jesuit, 2005). In the absence of increases in government transfers to lower-income families or increases in taxes to higher-income families, further increases in family market-income inequality would continue to be directly converted to increases in family after-tax-income inequality.
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