No.53-Redistributive Role of Public Transfer on Inequality in China

Cai, Meng; Yue, Ximing
Published: 2016/11/30 21:06:46    Updated time: 2017/4/11 20:55:59

Abstract: Objective of this work is to evaluate redistributive role of public transfer on inequality in China. We attempt to answer two questions in this paper. Firstly, does inequality of after-transfers income narrow, compared to that of before-transfers? Secondly, given scale and distribution of the existing public transfer, will a small percentage increase in the transfers narrow or widen the inequality of total income? By employing methodologies of MT index and decomposition of Gini coefficient of total income by its sources, we find positive answer to the first question and negative answer to the second question. Namely, the public transfers have a positive role on inequality, in the sense that Gini coefficient of after-transfer income becomes small, compared to that of before-transfer income. On the other hand, the public transfers have a negative role on the inequality, as the current inequality will go up if there is a universal increase in the public transfers for all recipients. Of all components of the public transfers, formal sector pension benefits and medical expense reimbursements are disequalizing for inequality of the total income, while the Dibao and rural pension benefits are equalizing.
Keywords: Public Transfer; Income Inequality

 Authors: 

Cai, Meng (School of Economics, Minzu University of China, Beijing China)

Yue, Ximing (School of Finance, Renmin University of China, Beijing China)

1. Introduction

Public transfers that households receive through social security schemes, one of the most significant systems to ensure and improve people’s livelihood and to promote social fairness and justice, has been established in more and more countries. As a main component of government public expenditure in many countries, social security expenditure is playing the most crucial part in narrowing the income inequality. The major reason for low inequality in developed countries, as plenty of international experience shows, lies in government redistribution policies, rather than market factors. Kristjánsson (2011) once studied on Gini coefficients of the three definitions of income in 16 OECD member states like Italy, Luxembourg, and the UK, and came to the result that in the 16 OECD member states in 2007, the market Gini coefficient was 0.483 while the Gini coefficient of disposable income was 0.289. The market Gini coefficient had fallen by 0.193, due to government redistribution policies, in which the public transfers took up 80.83%, much higher than the personal income tax and social security contribution by residents. The study of Milanovic (1999), Mahler and Jesuit (2006) on income distributions in several OECD states during 1967 to 2000 also showed that government transfers and personal income tax could bring down the income inequality index, with the pubic transfers particularly important, contributing to the income inequality improvement for as much as 80%. Similar to these developed countries in OECD, the social security schemes in some developing countries displayed a significant effect in narrowing the income inequality as well. Lustig (2011) studies redistributive role of government policies for Latin America countries and found that Brazil and Mexico also had a strong effect on income redistribution, explaining 75.2% of the improvement. It’s clear, therefore, from the experience of both developed countries and developing countries, the public transfers, with the social security expenditure as their income sources, always act as the primary strength of the government to improve income redistribution. Besides, it’s not market factors, but the less significant effect of the government income redistribution policies that leads to the situation of income inequality in China more serious than those developed countries (Cai and Yue, 2016). Thus, in order to achieve the goal of narrowing income inequality and realize social fairness and justice, we shall concentrate more on the redistributive role of public transfers.

The degree of the redistribution effect of the public transfer has much to do with its scale of the social security expenditures in government budgets, which are income sources of the public transfers. Generally speaking, most developed countries have a larger scale of social security expenditure, which puts forward a question that compared with other countries, China’s scale of social security expenditure is large or small. The ratio of social security expenditure to GDP is often used when comparing different expenditure levels of different countries. For example, in 1995, the average ratio of the social security expenditure in the eight countries including the UK, Sweden, Finland, Denmark, the US, Japan and so on to GDP is 32.2%1. In addition, the level of social security expenditure measured by this ratio is also closely related to the economic development. Taking GDP per capita as an indicator of countries’ economic development, the higher a country’s GDP per capita, the higher the level of its social security expenditure. This indicates a positive relationship between social security expenditure and economic development. Figure 1 displays the relationship between the ratio of social security expenditure to GDP and GDP per capita in 56 countries and regions in 2012. GDP per capita is on comparable base amongst countries.

[Figure 1 inserted here]

We can see from the figure that there is an obvious positive relation between GDP per capita and the ratio of social security expenditure to GDP, meaning that social security expenditure will increase as GDP per capita goes up. A fitted line from regression is also depicted in the figure and it’s clear that China locates below the fitted line, indicating that the social security expenditure is below average in China, even taking its stage of economic development into account. Predicted values of the ratio of the social security expenditure to GDP based on Chinese per capita GDP calculating from regression is 10.5%, which was high compared to 7.2% of the actual value. This finding is also supported in other studies. For example, according to the DSS research group of the Ministry of Finance (2007), during the period from 2002 to 2006, China’s social security level remained between 5.41% and 5.60%, lower than not only developed countries like the US, Germany or France, but also some developing countries like Kazakhstan, Poland and Hungary, as well as Argentina, Brazil and Uruguay in Latin America.

Low social security expenditure in China is one of obstacles for the social security programs to play strong role on inequality. Given scale of the social security expenditures, and hence the size of the public transfers received by households, degree of redistributive role of the public transfers depends on how the transfers are distributed among the households. If the public transfers were distributed so that poor people receive more transfers, then the transfers have a positive role on inequality. The more the transfers received by the poor, the bigger the role played on the inequality. If the transfers, however, were distributed concentrating on the wealthier people, the transfer will have negative role on the income distribution. To see the distribution of the public transfers, we need go to microdata at household level. This is main purpose of this study. Namely, objective of the study is to evaluate redistributive role of the public transfers in China by using household level data.

In measuring the distributive role of the public transfers in China below, we focus on two questions that need to be answered about the distributive role of the public transfers. Answers to the two question may have different, actually opposite, conclusions about the role of the public transfers on the inequality. One question is that, does inequality of after-transfers income narrow, compared to that of before-transfers? Another question is, given scale and distribution of the existing public transfer, will a small percentage increase in transfers narrow or widen the inequality? We find positive answer to the first question but negative answer to the second question. The two answers have clear different policy implications.