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A Critical Review of The Effects of Brazil’s Taxation and Social Spending on the Distribution of Household Income
Introduction
Built on the observation that Brazil has high taxation and significant social spending, Higgins and Pereira (2014) conducted a study on the effects of Brazil’s taxation and social spending on the distribution of household income. They introduced this study in the form of an essay in which they shared their analysis as professional economists. The aim of this study is to estimate the redistributive effect of fiscal policy on income distribution and poverty in Brazil. More specifically, the authors evaluated the effect of direct and indirect taxation, cash transfers, indirect subsidies, and in-kind benefits, on income distribution and poverty. The study reveals that on the spending side, although Brazil has some well-targeted anti-poverty programs, the poor still receives little social assistance, health spending, and education spending. As a result, inequality and poverty reduction are low relative to Brazil's spending. On the tax side, direct taxes and transfers reduce poverty and in-kind transfers are equalizing in the crowd of different income levels. However, these two parts account for little of the gross domestic product (GDP). In comparison, indirect taxes account for much of the GDP while indirect taxes paid by the poor often surpass the direct transfer and indirect subsidy benefits they receive. This means that high indirect tax revenue is not used to go back to the poor. This paper will review Higgins and Pereira's study as well as the result of their survey, and evaluate the efficiencies of Higgins and Pereira's method and focus on the limitations of the study.
Background
Latin America is one of the regions with the highest degree of inequality in the world (Ferreira and Ravallion, 2008). Brazil, as an important component country in Latin America, has high rates of taxation and large social spending relative to other countries (Higgins and Pereira, 2014). Judging from Brazil's tax system, it is exceedingly complicated, with more than eighty-five taxes (Portal Tributario, 2012). Higgins and Pereira declared that total fiscal revenues at the federal, state, and municipal levels were about 35 percent of the GDP in 2009. Direct taxes represent 45 percent of the taxes levied by the government, and indirect taxes represent 55 percent. The most important indirect tax is the Imposto Circulacao Mercadorias Services (ICMS), which is a state tax levied on the sale or physical movement of goods, freight, transportation, communications services, and electricity. There is a cascading effect in the Brazilian system, which derives from the fact that taxes levied at the federal, state, and municipal levels compound on each other. This effect occurs because the taxes are applicable to the final sales price of the goods (including taxes), not the pretax sales price. From the point of societal spending, there are three directions of expenditure. The first part includes social assistance, health spending, and education spending at the federal, state, and municipal levels. The second part is direct transfers, which include conditional cash transfer programs, noncontributory pensions, food transfers, unemployment benefits, special circumstances pensions, and others. The last part is in-kind transfers, which are benefits received from the universal free public education and health systems. However, regardless of the fact that Brazil has high rates of taxation and large social spending (Higgins and Pereira, 2014), just a small number of subsidies are sent to the poor. This seemingly contradictory phenomenon aroused the interest of the two authors to explore its reason.
Evaluation
Higgins and Pereira begin their research by analyzing Brazil's social spending (where the taxation goes) and taxation systems (where the taxation comes from). They find Brazil's high taxation and a large amount of social spending contribute to the pension system, transfers received, public education and health service, which would reduce inequality and poverty. However, as Higgins and Pereira (2014) analyzed, these transfers have relatively low per capita amounts, and a large portion of direct transfer beneficiaries are not given to the poor. In other words, a small amount of Brazilian government taxation is turned over to the poor. However, the strange thing is over the last decade, inequality has been falling in Brazil, as in other countries in Latin America (Lustig, Lopez-Calva, and Ortiz-Juarez 2013). Indeed, inequality has declined in Brazil every year since 2001. The recent diminution is mainly due to increased public cash transfers (Barros et al. 2010) and an equal distribution of educational attainment resulting from expanded access to education in the 1990s (Gasparini and Lustig 2011). Given these facts, after further analysis, Higgins and Pereira found that direct taxes and transfers also reduce the Gini coefficient. Gini coefficient is a measure of statistical dispersion intended to represent the income distribution of a nation's residents. In-kind transfers are particularly equalizing among the crowd in all levels of income. However, indirect taxes have a deleterious effect on post-fiscal income and often result in post-fiscal income poverty being higher than market income poverty. This special issue is devoted precisely to analyze the redistributive impact of taxes and transfers. The articles that follow estimate the redistributive effect of fiscal policy on income distribution and poverty in Brazil.
After analyzing Brazil's social spending and taxation systems, this article describes the data used as well as the methodology, which mainly focus on using stratified sample to sampling households, and propensity score matching (PSM) method suggested by Souza, Osorio, and Soares (2011) to impute benefits to the missing households. By using PSM method, both the number of beneficiaries and the total program benefits in their data approximate the corresponding amounts in national accounts. According to the Dictionary (n.d.), a stratified sample is a kind of sample that is not drawn at random from the whole population, but separately from a number of disjoint strata of the population in order to ensure a more representative sample. As Sanket Shah (2014) stated, PSM is a statistical matching technique that attempts to estimate the effect of a treatment, policy, or other intervention by accounting for the covariance that predicts receiving the treatment. PSM attempts to reduce the bias that could be discovered in an estimate of the treatment effect obtained by directly comparing outcomes among units that received the treatment with those that did not. This method has very little influence on inequality results, increases the poverty-reducing impact of direct transfers, and increases the coverage of direct transfers to the poor, compared to the results when the method is not implemented. Higgins and Pereira also think that by using this method, total benefits from the program are slightly lower than in national accounts.
This article supports the idea that through direct taxes and transfers poverty will be reduced, in-kind transfers are equalizing, and indirect taxes have a deleterious effect on post-fiscal income. However, it also comes with limitations. Indeed, the article does not respond to the research question adequately.
Firstly, the results of this research are obtained before many of the assumptions were met. For example, for tax to finance social services for workers (PIS) and tax on goods or services to finance pensions (COFINS), Higgins and Pereira utilize effective tax rates by decile calculated by Rezende and Afonso (2010). This means that the authors are assuming that consumers undertake all consumption taxes. However, economic incidence depends on the elasticities of demand and supply. The more elastic the demand or supply, the less the amount of the tax borne by the consumers or sellers, such as the tax for things like gasoline are shared and the tax for addictive substances like tobacco and alcohol are borne mostly by the consumer. Therefore, it is inaccurate to assume that the incidence of consumption taxes falls fully on customers.
Secondly, as explained by Lustig, Pessino, and Scott (2014), there is not agreement in the literature on whether contributory pensions should be treated as part of market income like income from savings or as a government transfer. Therefore, Higgins and Pereira should not see contributory pensions as government transfer or part of market income.
Even more notable is when Higgins and Pereira measured the Gini coefficient and Headcount Index, they used purchasing power parity (PPP) per day as the unit to measure the living standards of ordinary people. However, when using purchasing power parity as the unit, the per capita gross domestic product (GDP) can only show a total output value of the national economy, and cannot be precisely used as a measure of the living standards of ordinary people. Additional indicators, such as housing and the quality of school buildings, public service quality and level, the degree of pollution, the level of consumer protection laws, and so on, are difficult to determine. The purchasing power parity is not reflected in the gross national product (GNP). So even by purchasing power parity (PPP) adjusted per capita, the gross national product (GNP) should also be carefully used because it is one of the various standards of the quality of life. In fact, the standard of living is sometimes rarely affected by purchasing power parity (PPP). Therefore, Higgins and Pereira should not use purchasing power parity (PPP) per day as the unit to assess the living standards of ordinary people.
Conclusion
After reading the article, rather than stating that this study is a statistical study, the reviewer would recommend this as an investigatory study. The writing style of the researchers is well-organized. We can undoubtedly find although Brazil has high taxation, large social spending, well-targeted anti-poverty programs, and the inequality and poverty are decreasing; the fact is that social spending has relatively little influence on poverty alleviation policy. Furthermore, direct transfer reduces poverty while indirect transfer increases poverty, and the impact is larger than the direct transfer. In 2009, the average benefit per person living in beneficiary households was just US$0.35 per day (Higgins and Pereira, 2014).We can be able to see that the welfare of the poor was very little. The data also suggests that social spending will have little impact on the increased distribution of household income. This study will be beneficial for the reader and other interested in knowing about the effects of Brazil's taxation and social spending on the distribution of household income.
Reference
(n.d.). Retrieved April 3, 2015, from http://dictionary.reference.com/browse/stratified%20sample
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Ferreira, F., & Ferreira, F. (2008). Global Poverty and Inequality: A Review of the Evidence. Washington, D.C.: The World Bank.
Gasparini, Leonardo, & Lustig, N. (2011). The Rise and Fall of Income Inequality in Latin America. In The Oxford Handbook of Latin American Economics (pp. 691-714). New York: Oxford University Press.
Higgins, S., & Pereira, C. (2014). The Effects of Brazil’s Taxation and Social Spending on the Distribution of Household Income. Public Finance Review, 42(3), 346-367.
Lustig, N., Pessino, C., & Scott, J. (2014). The Impact of Taxes and Social Spending on Inequality and Poverty in Argentina, Bolivia, Brazil, Mexico, Peru, and Uruguay Introduction to the Special Issue. Public Finance Review, 42(3), 287-303.
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Shah, S. (2014, September 2). Quora. Retrieved April 3, 2015, from http://www.quora.com/What-is-score-matching