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All you wanted to know about...Gini Coefficient

MUTHUKUMAR K | Updated on January 08, 2018

India’s income inequality is at its highest level since the Indian Income Tax Act was introduced in 1922, claims a recent paper by well-known economists Lucas Chancel and Thomas Piketty. The top one percent of income earners are garnering 22 per cent of total income in India, which is the highest ever, they have found. While the period 1951 to 1980 saw the poor narrowing the income gap with the well-to-do, the trend has reversed over the period 1980-2014, they say. The Gini Coefficient for the country is estimated to be close to 0.50, which would be an all-time high.

What is it?

Gini Coefficient is a popular statistical measure to gauge the rich-poor income or wealth divide. It measures inequality of a distribution — be it of income or wealth — within nations or States. Its value varies anywhere from zero to 1; zero indicating perfect equality and one indicating the perfect inequality. Gini Coefficients can be used to compare income distribution of a country over time as well. An increasing trend indicates that income inequality is rising independent of absolute incomes.

There are many ways to measure it. Two popular ways are those based on pre-tax (or market) income and disposable income. The latter considers taxes as well as social spend before arriving at the figure. So in a sense, the difference between the two kinds of measures indicates the efficacy of a country’s fiscal policy in reducing the rich-poor divide through taxation and social spends. Chancel and Piketty’s report has used the pre-tax method of calculating the Gini Coefficient.

Why is it important?

A general rise in Gini Coefficient indicates that government polices are not inclusive and may be benefiting the rich as much as (or even more than) the poor. For instance, a subsidy on passenger train tickets may entail a big budget outlay and may be targeted at the poor. But its benefit could actually be derived by the non-poor. A Gini figure below 0.40 is generally considered to be within tolerable limits by economic experts. Chancel and Piketty’s report pegged India’s Gini coefficient at 0.41 to 0.49 for 2010. It is even likely that it crossed 0.5, which is an alarming level of inequality.

However, it is quite possible that the post-tax Gini Coefficient for India is lower, as government welfare schemes are focussed on the lower income groups. The progressive rates that India uses for income tax slabs could also narrow the disparity. Due to lack of data, we don’t have an inkling on this, though.

Why should I care?

It is important that rich-poor divide is kept in check to ensure that a larger section of society reaps benefits from economic growth. A higher Gini Coefficient also could mean temptation for an incumbent government to splurge more on welfare schemes and tax the rich more.

Moreover, the 1971 Nobel Prize winner Simon Kuznets had an interesting viewpoint. The Kuznets Curve demonstrated that economic growth initially leads to greater inequality, but as economy develops, market forces first increase and then decrease inequality levels.

This happens because the initial phase of economic growth boosts the income of workers and investors who participate in the first wave of innovation. This inequality, however, tends to be temporary as workers and investors soon catch up, resulting in improvement of their incomes.

The bottomline

Never let the Gini out of the bottle. Keep the growth card strong.

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Published on October 09, 2017

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