B (3:06)

Congratulations.

A (3:07)

Thank you. And those are primarily Latin America. Then for Latin America we've covered practically countries. So pretty soon we'll have results for 16 and the world bank has invited us to partner with them and do it outside the region. So we're covering Armenia, Jordan, Ethiopia, Sri Lanka, South Africa.

B (3:30)

Yeah. I'm looking here at the equity assessment homepage in progress. It looks to me like there's a couple of dozen. You named some Jordan, Nicaragua, South Africa, Sri Lanka, Tanzania, Tunisia, Venezuela. Yeah, it's become quite an ambitious effort.

A (3:45)

Yeah. Actually, the Gates foundation has given us resources to pilot it in Ghana and Tanzania. And also to convert our handbook into something that will have all the software that's needed to replicate this so people will be able to do the tech assessments on their own.

B (4:05)

So let's drill into one country. Pick a country that will illustrate.

A (4:10)

Well, we find. Yeah.

B (4:12)

Which country?

A (4:13)

Let me pick Brazil.

B (4:14)

Pick Brazil. Okay.

A (4:15)

Okay. Big country, Big country. Very important country.

B (4:18)

Reputation for being pretty well run, fairly pro in its policies, but also quite high rates of inequality, as is true throughout a lot of Latin America.

A (4:28)

Right. So what happens in Brazil when you look at direct taxes and cash transfers like Bolsa Familiar, it looks extremely good. It reduces inequality and reduces poverty substantially. When you compare, for example, with Colombia, that starts with a market income inequality similar to Brazil. Colombia does much less, however.

B (4:53)

So you would say the policies are progressive.

A (4:57)

They're progressive and pro poor. If you include. And that's what's so nice about the commitment to equity assessment. We don't end with the cash transfers. We also look at what happens when you add the effect of consumption taxes. When you add the effect of consumption taxes, then Brazil doesn't look so good.

B (5:18)

Consumption tax is also called a value added tax.

A (5:20)

It could be value added excise tax. In the US it's primarily sales taxes, so it varies by country. But in general, people think about this as a value added taxes.

B (5:30)

Taxes on tobacco and alcohol mostly.

A (5:33)

Huh? Exactly. But what happens in Brazil? Brazil has a very complex tax system and that results in taxing heavily what the poor consume, like beans and rice. Therefore, when you add that effect, actually poverty increases beyond what would have been with market income.

B (5:53)

So taxes in Brazil, even though they have this reputation as being pro poor and progressive, that is reducing inequality, they're taxing things that poor people use heavily enough that it's actually making poverty worse.

A (6:08)

Yes.

B (6:08)

And making inequality worse.

A (6:10)

No. And that's what's interesting. The two indicators can move in opposite directions.

B (6:15)

How could that be?

A (6:17)

Because when you measure, you know, let's take an example. If you have a tax system that taxes the poor, let's see, say we have two groups, poor and rich. And the poor pay 10% of their income in taxes and the rich pay 50%. That's the progressives. Right. However, the 10% for the poor in levels may be sufficiently high to make their poverty situation worse than it was before the taxes. So in one case we're looking at the difference between group. In the other case we're looking at the level. So taxes can be progressive and poverty increasing. And it's a very important point that actually the IMF has not been emphasizing enough in its recent reports because it's putting a lot of emphasis on inequality and not enough on poverty. I never dreamed I would say this, but that's what they're doing.

B (7:13)

So taxes can be. In the case, the simple case that you've described, there are two groups of people, the poor and the rich. The poor pay 10%, the the rich pay 50%. That's going to reduce inequality. But that 10% is enough to make the lives of the poor poorer than it would be otherwise. Well, presumably if I'm quite poor, any tax you collect from me is going to make me poor.

A (7:37)

Exactly. So how do you, what do you need to do in order to protect the poor? Usually not tax them. Yeah, first not tax them, but you know, then you know, you have the exemptions on food items in some countries, of course, you know, that also benefits the non poor. So you may argue, well, maybe it's better not to do that and give them cash transfers. The problem is that it's very hard sometimes to generate the programs that compensate the poor enough so that they're not impoverished by the system. The other thing you do with the, you know, we're talking now about cash, but the poor also receive transfers in kind, like free education, healthcare, free free health care, access to infrastructure. However, I think that the cash side has to be analyzed separately. It's all very good, but the poor have to eat first, right? So you can't feed them with education and healthcare. And that's why it's so important to look what happens on the cash dimension. And that's why Brazil is so interesting, because like you said, it's a country that's highly committed to reducing poverty and reducing inequality as much as they can, given all the constraints, fiscal and political constraints. But the political economy of federal and state taxes results in this phenomenon that I just described. And the Brazilians know it, by the way. It's a well known fact.

B (9:02)

So using this commitment to equity assessment, you say the Brazilians know it well. But is there something that comes out of the assessment where you could then say to the finance minister in Brazil, you know, you should do this instead of that and it's something that would be new to her, that she would not have known without the assessment.

A (9:21)

Well, another thing that we found out is that transfers to poor whites are higher than equally poor Afro descendants. That's new. And why is that? Because the Afro descendants are less involved in the formal sector than the whites. So there's something that the Brazilian. Brazilians would have to do in order to be able to deal with this gap, which is probably not there by design, because obviously they don't want to benefit the poor whites more than the poor blacks.

B (9:58)

But would you need the commitment to equity assessment to discover that you could just look at government transfers and say that they are discovered?

A (10:04)

No, you wouldn't know.

B (10:06)

You wouldn't see it straight from the transfers.

A (10:07)

No, no. People were very surprised by that result. I mean, then they start, you know, tying knots and saying, oh, yeah, this makes sense. Because what happens is that maybe Afro descendants somewhere in the rural areas, I mean, and the whites are more able to register in the cadastro, which is a system that they use to give people access to certain benefits, not bolsa familia. We're talking about other benefits that require to be enrolled in the formal social insurance system, even if you don't contribute.

B (10:37)

By the way, give me another country we've talked about Brazil. Pick another one that can shed light on why.

A (10:43)

Well, another country that you know, and these are preliminary results, we're looking at Ethiopia. Ethiopia is, contrary to Brazil, a very equal country. It has.

B (10:54)

Everybody's pretty poor.

A (10:56)

Everybody's pretty poor. So what? But we have the same phenomenon. Consumption taxes end up increasing poverty in Ethiopia as well. So here, I think this points to the fact that you probably need to be much more reluctant in requiring countries to mobilize domestic resources to deal with their needs for growth and macro sustainability.

B (11:26)

But wait a minute. We have this other line of analysis, not only here at cgd, but certainly here and elsewhere, saying that people who don't pay taxes demand nothing from their government, and the taxing them creates an incentive for them to hold their government accountable. I'm paying taxes, by gosh, why don't the schools work? So if you stop taxing the poor, which seems totally reasonable and fair, they have even less incentive to hold their government accountable.

A (12:00)

I don't think so. You know, for example, in Mexico, which, you know, in that case, Mexico is a little bit contrasting in that sense because it has a lot of exemptions and also because of informality, the poor.

B (12:11)

Informality, People who are working outside the formal economy.

A (12:13)

Yeah. You know, the rural areas, people don't pay the value added tax that much.

B (12:17)

Presumably that's true in Ethiopia and Brazil as well though. Yeah.

A (12:21)

Yes, but in Brazil, less so. But I mean we would have to sort of go into a lot of discussions about the why is that the case. But in the case of Mexico, you have the poor less heavily taxed than in other places. Yet through the Opportunidades program, which is the flagship cash transfer in Mexico, people, because it has a condition for people to be able to access health facilities and schools, they actually have become demanders of those services.

B (12:55)

Oh, that's interesting. So you create the incentive for them to care not because you tax them, but because you tell them they have to send their kids.

A (13:03)

Right.

B (13:03)

And then the kids go and they learn nothing. And then people are mad. It's like you tell me you have to send my kids to school, they better make the schools work.

A (13:09)

Exactly. So instead of having say, you know, you pay a different no, you wouldn't get this benefit unless you have this. So that created a bottom up demand for services in places where they didn't have them.

B (13:21)

We're going to take a break. When we come back, I have a feeling we didn't quite finish on Ethiopia and we had an interesting event here yester with Owen Barter debating Bill Easterly about whether or not development experts are complicit with dictators and Ethiopia featured very prominently. So we've got Ethiopia on the brain here. So I want to come back to that in a minute. This is Lawrence McDonald. I'm discussing the commitment to equity assessments with Nora Lestig who's the director of that program. She's a non resident fellow here at the center for Global Development and the project is joined with cgd, Tulane University and the Inter American Dialogue. Be back in a moment. Welcome back to the Global Prosperity Wonkcast. My guest today is Nora Lustig. We're talking about whether or not government policies improve or worsen inequality. And Noor's developed a new tool, the commitment to equity assessment. Nora, we were talking about Ethiopia and you started to say that in Ethiopia, as in Brazil, that taxes on the poor are impoverishing. Do they also exacerbate inequality?

A (14:51)

No. So that's what's interesting again in the Ethiopian case they don't. But as I was saying earlier, I think the Ethiopian case is a good example on how difficult it might be if you want to fulfill the three goals that everybody wants to fulfill, which is providing the population with a minimum living standard, investing for Growth and also ensuring macroeconomic sustainability, meaning that you don't have excessive fiscal deficits or debt that cannot be paid back or runaway inflation. It seems that if you try to rely on domestic mobilization in countries that are very poor, it's going to be hard not to hurt the poor. So I think that it shows, the Ethiopian case shows that probably filling the gaps with external resources, if you really care about fast tracking poverty reduction may be required.

B (15:56)

This sounds so old school. I mean, this is what people were saying this was the rationale for aid. And now we've had a whole generations of studies of aid effectiveness that have documented various ways in which it creates perverse incentives and reasons it might not work. But it sounds like your work is sort of like a back to the future situation where if you really want to jumpstart growth, you need investment, you can't generate the resources. If you generate the resources by taxing poor people, it's impoverishing.

A (16:30)

Yeah, it's a trilemma because if you do, or if you want to put it on one side, investing for growth and making sure you don't have macroeconomic imbalances and make the whole thing unsustainable. And at the same time, like I said, fast track poverty reduction, I don't think you can do it.

B (16:53)

What are the lessons from East Asia, the countries that grew well and reduced poverty? I'm thinking Korea, Taiwan, Singapore, Thailand, perhaps even Indonesia. Did they do this? Mostly. How did they get out of the trilemma? Did they tax the poor but make good use of the money that they raised so that eventually it became less of a problem?

A (17:17)

I think, you know, let me be careful about this because I have not studied this historically, but I think that in those cases the main contributor to poverty reduction was growth. And it is an effective way of doing it. But again, if you want to fast track it, if you want to do it more quickly. Now, let's say you think that everybody should have a minimum living standard and you want to ensure that that happens in all the countries in the world, then that is not compatible in the poorest countries. I'm talking about low income countries with at the same time asking for they to pay for their investment projects.

B (18:04)

Where do you see your project going next?

A (18:07)

Well, right now, I mean, at the beginning I was trying to see whether we could make sure that we had funding to this on a recurrent basis. I hope that at some point this becomes an inherent part of the monitoring process of what's going on in countries. Instead, mainly following the demand, we have expanded globally because the beginning was a Latin American project. We're trying to see, okay, let's implement a process in which we can do this every three years to see how much progress was made between point A and point B. But right now we're trying to cover as many countries as possible in a way that will give us a sense of different models that exist in the world and what we can learn from one or the others. And then later on, we hope that this will be a recurrent process. We want this to become an instrument for governments and multilateral institutions, NGOs that went into our social progress to see what is happening with the fiscal resources in terms of how they're collected and how they're spent.

B (19:16)

Are there any countries in the ones you've studied so far in these studies in progress that you would hold up as an exemplary to say this country's doing a pretty good job? You know, other countries should pay attention.

A (19:28)

Well, so far, the country I'm smiling because it's a small country, but one of the countries that looks the best so far is Uruguay. I don't know whether that can be replicated. It's one of the most equal in Latin America. If you compare it with inequality in Asia, it doesn't look so equal. And it's done a pretty good job in terms of providing a floor for its citizens and also reducing inequality further through its tax on spending program.

B (20:01)

Would this come as a surprise to people who know Latin America? I don't often hear people talk about Uruguay.

A (20:07)

No, it wouldn't, because Uruguay sort of matches people's priors.

B (20:11)

This is a country that's pretty well.

A (20:12)

I think Uruguay would match people's priors. We also find one problem in Uruguay is the spending on tertiary education is not progressive, meaning that the poorer segments of the population do not get to use it. And that means Uruguay has a problem because there's a very high rate of dropouts in high school. And so we also detected a problem. Where's the problem there? It has to do with its educational system. Maybe because it's too demanding, maybe not. It's not because it's of low quality, maybe it's too demanding. And people who come from poorer backgrounds do not keep up with what's required in high school and therefore they cannot make use of the free tertiary education.

B (20:58)

I want to ask you something somewhat technical that came up before we started the show and that is, as I've understood this in its very simple terms, the very simple terms I described it at the beginning, that you have a sort of a market rate of income and then you look at what taxation does to that market rate and then what spending does to that market rate. But of course, in reality, we can never perceive the market rate because all these other things have already happened. They're happening all the time. So what we can only do, I suppose is start at the end of the process and unpack it in reverse.

A (21:33)

Is that it's a combination. But. Well, there's two issues here. One is what the data gives you when you collect. I mean, all the, I guess, you.

B (21:44)

Know, market income, pre taxation. So that's some stuff you do.

A (21:47)

But. But the household surveys, which is our main database for all this, often do not report how much people pay in taxes. So you need to simulate it. And if you do it right, you need to simulate it with assumptions about evasion and other things that are important when you simulate the tax rates. But from an economic point of view, what we never are able to calculate is a counterfactual income. What would be the economy like if you didn't have the fiscal system? We go through approximations. What do I mean by that? Well, in our current methodology, it's called the accounting approach because we just look at how revenues are collected and how spending flows without trying to assess what would happen without any of the taxes that we're interested in on behavior. Let's say, for example, if you reduce taxes on food, that then in economics it would tell you probably that people would buy more food than other things. It would be a substitution. We don't model that that's going to be in the next stage. Since you were asking for what we anticipate in the future. If you get rid of pension income, people will not be having zero incomes. The elderly would work, would work more years. And we see that whenever there is a shock to people's pensions, as we had recently because the retirement incomes fell as a result of the market crash. So that behavior we're not modeling yet, but that would approximate more what you would expect in the absence of the fiscal system. But that's the next stage. Right now we're just looking at who pays what and who receives what.

B (23:45)

Could you imagine, you know, as you do more and more of these assessments, that in a large number of cases government actions are going to be worsening the lot of the poor and exacerbating inequality. And a libertarian could look at this and say, see, I told you so. If government would just get out of the way, stop taxing people and trying to provide services, the Market would take care of it all. Are you creating a base for a libertarian argument here?

A (24:17)

Funny that you ask, because I joke sometimes. I say I'm becoming a Tea Partyer. When I see in some cases that the state ends up making poverty worse, then I think it doesn't mean that you have to go to the extreme of saying the government is always going to make things worse. What this tells us is we need to measure it and then see how we can correct it. Because at this point, often people do not see the problem. They may know it exists. Like I said, in Brazil, people knew that the consumption taxes were.

B (24:53)

Well, the rich and powerful are pretty effective at getting things to work in their own interests.

A (24:57)

Yeah, people know. But it's very different to know that this may be happening from having a measure that says this is the extent to which this is happening and this is how much you would have to spend in order to correct this, or this is how much taxes would have to be reduced in order to correct it.

B (25:14)

Have you seen any instances where these findings have begun to filter their way into the political and policy debate?

A (25:20)

Yes, we saw it in Costa Rica, for example, where the results also show that they were considering a reform that would eliminate exemptions on food consumption. And UNDP met with the Minister of Finance and they showed results from our exercise and other exercises that indicated that this would be very hurtful for segments of the poor population. And apparently the Minister of Finance decided to reconsider some of the policies. The other thing we found is, for example, in the case of Indonesia, the government asked the world, because we're working with the World bank on the Indonesian case, asked the World bank that they want train people in house because they would like to incorporate this as a regular exercise. The same thing in South Africa. The demand to have this assessment came directly from the budget office in the Ministry of Finance. So it is actually being taken as something serious by the people that will be making decisions. So that's very gratifying for us, as you can imagine.

B (26:27)

Well, that's very exciting indeed. Nora, you and I have known each other for some time. We first met at the World bank working on the World Development Report on poverty. And was it 19?

A (26:36)

It was 2,000?

B (26:37)

2,000. 2,000. So it's really nice to get to see you and find out what you're up to. And this is a very exciting project. Thanks for coming to tell us about it.

A (26:45)

Thanks for having me.

B (26:46)

This is the Global Prosperity Wonkast from the center for Global Development. My guest today is Nora Lustig. We've been talking about her commitment to equity assessments. CGD is proud to be a partner in this new effort, which looks at how government policies, both taxing and spending, affect inequality and poverty. You can find the Wonk cast online on itunes and on Stitcher. Just search for wonkcast or CGD to hear a new interview every week. Until next time, I'm Lawrence MacDonald. Thanks for listening.

A (27:25)

Sam.