Up to the late 1990s, a certain smugness was evident in studies of Canadian income inequality. While an upward trend in inequality was evident in the United States and Britain by the 1980s, any signs of rising income inequality in Canada appeared to be offset by the welfare state. Taxes and transfers were doing their job. Canadians might not be as kind and gentle as the Swedes but we were certainly kinder and gentler than those nasty Americans or the increasingly unlovely Brits.

However, it turned out that Canada was not different from the United States and Britain, just a little behind. In the latter half of the 1990s, income inequality in Canada surged upward after four decades of relative stability. This surge in inequality is especially disturbing because it occurred during a period of economic expansion when, if anything, we should expect inequality to decline. A reasonable expectation given its cyclical nature was that by 2003 or so our Gini index of inequality would have fallen back to 1989 levels, just under 0.28. Instead, it was close to 0.32.

When inequality or poverty measures change significantly, there are always three likely suspects to account for the shift: changes in labour markets (e.g. rising earnings inequality), changes in families (e.g. more lone parents) and changes in public policies (cuts to the “welfare state”).

Given the timing of the inequality surge, it is tempting to point the finger at the welfare state. The latter half of the 1990s was the period when Unemployment Insurance (UI) became Employment Insurance (EI) and access to benefits became more restrictive. Social assistance benefits were overhauled in a number of provinces, especially Alberta, British Columbia and Ontario. And federal and provincial surtaxes on high-income earners were abandoned.

As it turns out, however, these efforts at welfare state “retrenchment” constitute a small part of the story. Two recent studies of the effect of taxes and transfers on this trend tell much the same story,¹ and the answer is not as simple as one might suspect.

The redistributive impact of taxes and transfers on income inequality has actually risen, not fallen, over the past two decades. So despite the retrenchment efforts of the 1990s, the welfare state has not been withering away. However, it has not been keeping pace with the changes in labour markets and families that are driving the surge. During the 1980s, the increase in the redistributive effect of taxes and transfers more than offset the increase in inequality due to changes in labour markets and families. By contrast, between 1989 and 2004, the increase in the redistributive effect offset less than a quarter of the increase due to changes in labour markets and families.

The main conclusion from these studies is that politics and policy change matter a little but not very much. The other two suspects, changes in labour markets and especially changes in families, matter much more. However, that leaves open the question: what might have happened had the Canadian welfare state taken a more aggressive stance toward the underlying trends in labour markets and family formation? Fortunately, the experience of the province of Quebec provides some clues. As Pierre Fortin documents in this issue, policy and politics do matter.² Quebec’s more aggressive approach to family well-being has mattered a lot.

Changes in labour markets are important but for most families/households, changes in family formation and the family life course are the big drivers of the surge in inequality. Aggressive policy change was required to keep pace with these developments. Outside Quebec, that didn’t happen.

So what did happen?

Figure 1 illustrates the main story: the surge in market family income inequality that extended from roughly 1980 to 2000. Market family income refers to all income that family members (and unattached persons) bring home from work or receive in the form of dividends, rents and the like. It does not include income transfers from government or take account of taxes paid.

The stunning fact here is that for three decades market incomes in the middle and the bottom of the income scale have been essentially stagnant while incomes at the top have been rising. Canada has been producing more wealth, but the bottom half has not been getting its share. In the early postwar decades in the United States, a rising tide was lifting all boats. While Canada does not have data for those decades, it is likely that trends were similar north of the border. So what accounts for this historic shift?

Changes in labour markets matter. Surging compensation among the top 1 per cent was a key factor.³ Declining unionization rates played an important role, as did the declining earnings of recent immigrants.⁴ Rising inequality in male and female earnings and rising returns to education were also important. But the main conclusion of a recent fine study by Yuqian Lu, René Morissette and Tammy Schirle is that changes in families matter more.⁵ This is a nontrivial result, since family formation and family behaviour are not easily amenable to policy intervention.

Divorce rates have risen and marriage rates have fallen. There are many more lone parents raising children as a result and fewer adults are benefiting from the economies of scale associated with shared living arrangements or the “insurance” provided by an employed spouse during spells of unemployment. The result is a “quantity” problem. Some households have lots of labour to sell (two or more earners) while more families have comparatively little (single-earner households with and without children).

Changes in families can have offsetting effects. Rising education and employment rates among women have had strong equalizing impacts among families. But the relative importance of these changes depends on who marries whom. Educational “homogamy” (the tendency of like to marry like) has risen substantially since the 1970s. Between 1971 and 2001, the proportion of educationally homogamous marriages among young Canadian adults (34 and under) rose from 42 per cent to 55 per cent of all marriages. This was a period when the employment and earnings gap between the more and less educated was also rising. This can be thought of as a “quality” problem: the divide between households with lots of high-quality (educated) labour to sell and those with fewer labour market skills has grown.

To illustrate, consider Figure 2. In 1980, the highest-paid wives were married to men earning between $30,000 and $40,000 per year. Women married to men earning less than $30,000 earned substantially less – and so did women married to men earning more than $40,000. By 2000, in contrast, all this had changed. Women married to men with low earnings (less than $10,000) saw their own relative earnings fall by about 35 per cent, while women married to men with high earnings saw their earnings rise by about 21 per cent. In 1980, the relationship between husbands’ and wives’ earnings looked somewhat like an inverted U: women married to men in the lower middle of the earnings distribution were earning the most. By 2000, the relationship was such that the highest-paid women were married to the highest-paid men, and the lowest-paid women to the lowest-paid men. And over the entire period, rising returns to education favoured families in the top half of the scale.

That well-educated women and men tend to marry each other and subsequently have high earnings and low rates of unemployment is unlikely to change as a result of public policy. A “Lavalife Canada” program aimed at introducing university grads to high-school dropouts is not on anyone’s policy agenda for the near future.

There has also been a steady increase in lone-parent families – from about 6 per cent of all families in 1980 to 11 per cent in 2005 – and a rising number of families without kids. Lu, Morrissette and Schirle estimate that, together, these changes accounted for about 20 per cent of the rise in inequality since 1980.

There were some good news stories over the period. Between 1980 and 2000, employment earnings among lone mothers rose by 39 per cent as a result of rising employment rates. This led some observers to conclude that “tough love” policies in some provincial social assistance schemes, notably B.C., Alberta and Ontario, had been effective. Colleagues and I showed, however, that most of these gains were the result of changes in the demographic composition of lone mothers: by 2000 lone mothers were simply older, better educated and hence more likely to be employed than in 1980.⁶

The outstanding exception was Quebec. Quebec lone mothers had the largest employment gains in the 1990s (9.4 percentage points) and by 2000 their employment levels were four percentage points higher than in the rest of Canada. Demographic changes in Quebec accounted for only 28 per cent of the growth in lone mothers’ employment in the 1990s, results that are consistent with conclusions concerning the effects of liberalized child care provisions in that province.⁷

The interesting puzzle here is that while the surge in income inequality measured after taxes and transfers did not appear until the latter half of the 1990s, the growth in market income inequality had been underway for at least a decade and half by then. In their new study of the impact of taxes and transfers on income inequality, Marc Frenette, David Green and Kevin Milligan show that growth in market income inequality was roughly similar in the 1980s and the 1990s.⁸ The ratio of those at the 90th percentile to those at the 10th percentile grew by 12.8 per cent between 1980 and 1990 and by a further 11.4 per cent between 1990 and 2000. As they demonstrate, this was because income redistribution was rising between 1980 and 1995, offsetting changes in the labour market and families.⁹ These changes did not result in less inequality; rather, the welfare state was running hard to keep inequality levels stable.

Importantly, rising income redistribution through the 1980s and the first half of the 1990s was largely driven by changes at the provincial level, a result of rising transfers under social assistance and surtaxes on top-earning families. As a result, the level of income redistribution peaked in 1995 but then declined because of cuts to social assistance, changes in UI and the elimination of surtaxes on high-income families.

However, the important conclusion is that inequality would have risen even in the absence of these cuts.¹⁰ The big story of the 1990s was not so much one of retrenchment – the tax-transfer system in 2000 was still much more redistributive than that of the 1980s – but rather of the failure of the tax-transfer system to expand and to keep pace with underlying trends toward increasing inequality in labour markets and families. In short, at the national level, the welfare state was “running out of gas.” And most of the action was at the provincial, not the federal, level. As Frenette, Green and Milligan conclude, “The steady after-tax income inequality of the 1980s arose because the tax and transfer system increased its redistributiveness over that decade. In the 1990s, the tax and transfer systems ceased becoming more redistributive, allowing the changes in pre-tax inequality to pass through to increases in after-tax inequality.”¹¹

We still need Robin Hood

So what should we make of all this? Big changes in labour markets and especially families have been driving the inequality surge. As a result, welfare states have had to run fast simply to keep the income distribution standing still. The impact of labour market and family changes, moreover, have been especially severe for young adults (those under 35). Their work careers have been starting later and their earnings relative to older adults have been falling since the 1980s. As a result, we have made relatively little progress in reducing child poverty. While the social and economic life course has changed, the biological life course has not. Because of biology, young adults (under 35) are still the parents of the majority of our young children – 60 per cent of those under six – and no social policy can change this.

If we look at the world from the vantage point of the young adults who are entering the labour market today and who will be supporting our pensions and health care system for the next 30 years, things look a little gloomy for the bottom half.

The world our thirtysomethings of today are entering is very different from the one encountered by the young cohorts of even a quarter century ago. A new high-inequality equilibrium in the distribution of family earnings has emerged and appears to be a relatively permanent feature of our postindustrial world. The cohorts turning 30 this year and those now completing their schooling will make up the core of our prime-age workforce well into the 21st century.

Changing the labour market would help the most. Most people get most of their income from employment for most of their lives. Full employment and decent wages for the employed, not generous welfare states, were the primary objective of social democrats and reformers like John Maynard Keynes and William Beveridge who sought to shape postwar societies in the 1940s. Countries could afford generous welfare states under conditions of high employment and high wages at the bottom of the scale, but not otherwise.

But labour markets change only over the long term. Canada has lots of low-wage jobs by international standards, and that has ever been so. Cross-national differences in wage structures of the current magnitude are the product of longstanding historical differences in wage-bargaining institutions and labour market regulation. Institution building and reform are by definition long-term projects.

Early childhood education programs intended to compensate for the weak cultural capital of many low-income parents have come into favour in many policy circles. Economists like human capital investments of this sort, and so do I. Improving people’s capabilities, as Amartya Sen argues, should always be at the top of our agenda. But the distribution of human capital among those now entering the labour market is unlikely to change very much over their working lives. Early childhood education looks like it could help a lot – but not until the kids who benefit enter the labour market some 25 years in the future.

I value the search for alternatives and complements to the tax-and-transfer welfare state – Robin Hood. And the Quebec experience demonstrates that it’s not just about Robin Hood. While improved transfers were a factor in Quebec’s better performance, Quebec’s child care program is also an “employment” program, enabling single moms and women married to low-wage men to enter the labour market and raise the living standards of their families. Nevertheless, my conclusion is that we are probably going to need more rather than less Robin Hood for some time to come.

Notes

¹ Andrew Heisz, “Income Inequality and Redistribution in Canada: 1976 to 2004,” Statistics Canada, Analytic Studies Branch Paper Series, No. 298, May 2007; Marc Frenette, David Green and Kevin Milligan, “Looking for Smoking Guns: The Impact of Taxes and Transfers on Canadian Income Inequality,” Canadian Public Policy, in press.

² Pierre Fortin, “Quebec is Fairer: There is Less Poverty and Less Inequality in Quebec,” Inroads, Winter/Spring 2010, pp. 58–65.

³ Emmanuel Saez and Michael R. Veall, “The Evolution of High Incomes in Northern America: Lessons from Canadian Evidence,”American Economic Review, Vol. 95, No. 3 (June 2005), pp. 831–849.

⁴ John DiNardo, Nicole Fortin and Thomas Lemieux, “Labor Market Institutions and the Distribution of Wages, 1973–1992: A Semiparametric Approach,” Econometrica, Vol. 64, No.5 (1996), pp. 1001–44.

⁵ Yuqian Lu, René Morissette and Tammy Schirle, “The Growth of Family Earnings Inequality in Canada, 1980–2005,” Presentation to Canadian Economic Association annual meetings, 2009.

⁶ John Myles, Feng Hou, Garnett Picot and Karen Myers, “Why Did Employment and Earnings Rise among Lone Mothers in Canada during the 1980s and 1990s?”, Canadian Public Policy, Vol. 23, No. 2 (2007), pp. 1–26.

⁷ Michael Baker, Jonathan Gruber and Kevin Milligan, Universal Childcare, Maternal Labor Supply, and Family Well-Being, National Bureau of Economic Research Working Paper No. W11832, 2005; Pierre Lefebvre and Philip Merrigan, Low-fee ($5/day/child) Regulated Childcare Policy and the Labor Supply of Mothers with Young Children: A Natural Experiment from Canada, Centre Interuniversitaire sure le Risque, les Politiques Économiques et l’Emploi (CIRPEE), Cahiers de recherche 0508, 2005.

⁸ Frenette, Green and Milligan, “Looking for Smoking Guns,” p. 10.

⁹ See also Heisz, “Income Inequality and Redistribution in Canada.”

¹⁰ Frenette, Green and Milligan, “Looking for Smoking Guns,” p. 13.

¹¹ Ibid., pp. 30–31.

 

Suggestion for further reading

The Canadian experience over the last quarter century is a national variant of distributional trends in all Western societies. For further reading on these developments, see Gosta Esping-Andersen, The Incomplete Revolution: Adapting to Women’s New Roles (Cambridge, UK: Polity Press, 2009).