## _012314 - EXECUTIVE SUMMARY ## Source details **Canonical URL:** [_012314 - EXECUTIVE SUMMARY](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_012314.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_012314.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_012314.pdf.json) --- ### Overview and scope - Fiscal policy is the primary tool for governments to affect income distribution. - The paper describes: - recent trends in the inequality of income, wealth, and opportunity in advanced and developing economies; - country experience with different fiscal instruments for redistribution; - options for reform of expenditure and tax policies to help achieve distributive objectives in an efficient manner consistent with fiscal sustainability; - recent evidence on how fiscal policy measures can be designed to mitigate the impact of fiscal consolidation on inequality. - The paper does not advocate any particular redistributive goal or policy instrument. ### Key findings on trends and macroeconomic context - Income inequality has increased in both advanced and developing economies in recent decades. - Contributing factors include: - globalization and liberalization of factor and product markets; - skill-biased technological change; - increases in labor force participation by low-skilled workers; - declining top marginal income tax rates; - increasing bargaining power of high earners; - growing share of high-income couples and single-parent households. - There is growing evidence that high income inequality can be detrimental to the pace and sustainability of growth and possibly related to financial vulnerabilities. - Public demand for redistribution has risen, especially in countries strongly affected by the crisis, while high public debt ratios and emerging vulnerabilities have made fiscal restraint an important priority. - Fiscal policy affects distribution both directly (income taxes and cash transfers affecting disposable income) and indirectly (in-kind benefits such as education and health affecting future market incomes). ### Trends in personal income and wealth (selected facts) - Gini and regional patterns: - Between 1990 and 2010, the Gini for disposable income increased in nearly all advanced and emerging European economies. - Over one-third of advanced economies and half of emerging Europe experienced increases in their Ginis exceeding 3 percentage points. - Between 1990 and 2010, average inequality in each region changed by less than 3¼ percentage points. - Average inequality in sub-Saharan Africa and Latin America remained about 12 percentage points higher than in emerging Europe and advanced economies. - Rising top-income shares (United States example): - Share of market income captured by the richest 10 percent: around 30 percent in 1980 to 48 percent by 2012. - Share of the richest one-percent: 8 percent in 1980 to 19 percent by 2012. - Share of the richest 0.1 percent: 2.6 percent in 1980 to 10.4 percent by 2012. - Wealth trends and concentration: - For eight large advanced economies, the average ratio of net household wealth to national income grew by almost 80 percent between 1970 and 2010. - Italy: largest increase by 180 percent. - United States: smallest increase by 21 percent. - Wealth is more unequally distributed than income: sample of 26 economies—wealth Gini = 0.68, disposable income Gini = 0.36. - Share of wealth held by the top 10 percent varies (examples preserved exactly): - slightly less than half in Chile, China, Italy, Japan, Spain, United Kingdom; - more than two-thirds in Indonesia, Norway, Sweden, Switzerland, United States. - Switzerland and United States: top one-percent alone holds more than one-third of total household wealth. - United States: wealth Gini rose from 0.80 in the early-1980s to almost 0.84 in 2007. - Lifetime inequality: - Lifetime inequality is typically about 20–30 percent lower than annual income inequality in Canada, the United Kingdom, and the United States. - Sweden: lifetime dispersion about 35–40 percent lower than annual income. - Inequality of opportunity and intergenerational mobility: - Intergenerational earnings mobility is low in Italy, United Kingdom, United States and much higher in Nordic countries. - In low-mobility countries, about 50 percent of an economic advantage a father has is passed onto his offspring; in high-mobility countries this falls to less than 20 percent. ### Public support for redistribution (survey evidence) - Surveys and coding: - World Value Surveys (WVS), Regional Barometers, International Social Surveys; Integrated Values Survey 1981–2008 cited. - WVS scale 1–10: responses 1–5 coded as support for more redistribution, 6–10 as support for less. - Trends: - Between the late-1990s and the late-2000s, public support for redistribution increased in almost 70 percent of advanced and developing economies surveyed. - Late-1990s: 15 economies out of 57 (26 percent) showed majority support for more redistribution; by the late-2000s this rose to 56 percent of countries. - Support grew more in countries where inequality increased; public support grew by more than 30 percentage points in China, Finland, Germany and several Eastern European countries where the income Gini increased by over 20 percent. - Between 2008 and 2011, among advanced economies, public opinion shifted more in favor of redistribution in countries that experienced large declines in GDP (examples: Portugal, Ireland, Slovenia). ### Poverty trends in developing economies (absolute poverty) - Poverty measure: percentage of population below $1.25 per capita per day in 2005 PPP dollars. - Sub-Saharan Africa: sustained growth and declining average inequality led to substantial decline in absolute poverty rates. - Asia and the Pacific: high growth produced larger decreases in absolute poverty despite rising average inequality. - Absolute poverty also trended downward in Latin America and the Caribbean and in the Middle East and North Africa since the mid-1990s. ### Fiscal instruments and country experience - Both tax and expenditure policies need careful design to balance distributional and efficiency objectives, including during fiscal consolidation. - Appropriate instrument mix depends on administrative capacity, societal preferences, role envisaged for the state, and political economy. - Country experience and IMF technical assistance reports identify options achieving distributional objectives at minimum efficiency cost. ### Recommended options to minimize efficiency costs - Advanced economies (selected recommendations): - use means-testing with gradual phasing out of benefits as incomes rise to avoid adverse effects on employment; - raise retirement ages in pension systems with adequate provisions for the poor whose life expectancy could be shorter; - improve access of lower-income groups to higher education and maintain access to health services; - implement progressive personal income tax (PIT) rate structures; - reduce regressive tax exemptions. - Developing economies (selected recommendations): - consolidate social assistance programs and improve targeting; - introduce and expand conditional cash transfer programs as administrative capacity improves; - expand noncontributory means-tested social pensions; - improve access of low-income families to education and health services; - expand coverage of the PIT. - Innovative approaches applicable to both country groups: - greater use of taxes on property and energy (such as carbon taxes). ### Design principles and efficiency considerations - Overarching objective: achieve distributional goals at minimum cost to economic efficiency while maintaining fiscal sustainability. - Direct instruments based on income are generally more efficient: personal income taxes preferred over consumption taxes; cash transfers preferred over price subsidies. - Targeting reduces fiscal cost but carries efficiency costs and must be designed to avoid adverse incentives. - Joint evaluation of tax and expenditure policies is essential because trade-offs differ across instruments. - Optimal marginal income tax structure (Mirrlees/Diamond-Saez summary): - Typical U-shaped pattern: high at the bottom, low for middle incomes, high at the top. - Earned income tax credit / in-work benefits can reduce marginal tax rates for low-income workers and improve labor participation. - Revenue-maximizing top PIT rate estimates generally range between 50 and 60 percent; Piketty, Saez, and Stantcheva (2011) argue it may be up to 80 percent under extreme assumptions. ### Social spending, pensions, and labor market interactions - Social spending is the primary instrument for redistributive goals; efficiency gains come from improving targeting and reducing adverse labor market effects. - Pension-specific facts and recommendations: - Pension benefits account for about two-thirds of social protection spending. - Average pension spending is projected to rise by an additional 1½ percent of GDP by 2030. - Reforms to preserve redistribution while containing spending growth include increasing effective retirement age, linking eligibility to years of contribution, enhancing earning opportunities for older, low-skilled workers, incorporating pension incomes into a progressive income tax system, scaling back tax subsidies for private pensions, and making benefit cuts progressive. - Developing-economy pension considerations: - Expand noncontributory social pensions (flat pensions aimed at poverty reduction); cost examples and containment: - Cost of social pensions can be substantial at about ½–¾ percent of GDP. - Pension expansion to cover elderly poor: cost examples range from 0.7 percent of GDP in Madagascar to 2.4 percent of GDP in Ethiopia. - Limiting the pension to only the elderly poor "would approximately halve this cost for most countries." - South Africa’s Social Grants Program includes a means-tested social pension program costing 1.3 percent of GDP. - Active labor market programs and in-work benefits: - In-work benefits can increase labor force participation; empirical evidence shows positive net employment effects in the United Kingdom and the United States, especially for single women with children. - In some evaluations, 70 cents per dollar spent on the earned income tax credit ultimately benefits employers by reducing their labor costs. - Caution: administration requirements and fiscal costs may limit viability in many developing economies. - Family benefits: - On average, in 2005, family benefits decreased the disposable income Gini by nearly 1.5 percentage points, accounting for nearly three-quarters of the redistributive impact from total social assistance spending. - 2010 spending statistics preserved exactly: - "Average total spending = 2.2%" - "Average non means-tested spending = 1.8%" ### Social assistance and safety-net reforms in developing economies - Common shortcomings: - Fragmentation and duplication across programs; - Bad targeting: median share of social assistance transfers accruing to the bottom 40 percent is 46 percent; median social assistance spending was 0.76 of a percent of GDP; eliminating leakage of 54 percent of total spending would reduce spending by 0.41 percent of GDP. - Low coverage: median coverage could be expanded from 38 percent to 82 percent using savings from better targeting. - Reliance on costly in-kind benefits: overhead costs can be "as much as 50 percent higher than the value of the in-kind benefit to beneficiaries". - Reliance on universal price subsidies: example figures preserved exactly: - in sub-Saharan Africa, spending on energy subsidies in 2011, on a post-tax basis, equaled 3½ percent of GDP; - in the MENA region, 14½ percent of GDP. - Distributional skew: the richest 20 percent reap about 43 percent of benefits from energy subsidies in developing economies, poorest 20 percent receive 7 percent. - Policy recommendations: - Consolidate benefits into fewer programs with clear objectives; - Improve targeting and scale down price subsidies to enhance poverty impact and create fiscal space; - Use savings to finance more effective safety nets with expanded coverage. ### Conditional cash transfers (CCTs) and public works - CCTs: - Typical features: proxy means tests, three-year conditionality on school/clinic attendance. - Cost and coverage examples (2012): Brazil (Bolsa Familia) cost 0.5 percent of GDP and covered one-quarter of the population; Mexico (Oportunidades) cost 0.8 percent of GDP and covered one-fifth of the population. - Impacts: substantial impacts on poverty, inequality, education and health; direct impact in Brazil and Mexico accounts for one-fifth of the decrease in the Gini between 1995 and 2004 in these two countries. - Requirements: administrative capacity and access to basic education and health services; more suitable initially for emerging than low-income economies. - Public works: - Design to encourage self-selection (wages below market for unskilled labor), time programs to avoid peak employment seasons, and in emerging economies add infrastructure/training components. ### Education policy to improve access and mobility - Findings: - Regressive incidence of education spending in developing economies reflects lower access by low-income groups to upper secondary and tertiary education. - In advanced economies, tertiary education spending tends to be regressive. - Lack of access perpetuates inequality of opportunity across generations. - Recommendations: - Increase investment in lower levels of education (primary, lower-secondary, early childhood), with focus in developing economies on girls and rural areas; in advanced economies on higher-secondary and tertiary progression and performance. - Improve efficiency of education spending (complement increased spending with better outcomes). - Increase cost recovery in tertiary education via tuition fees and income-contingent student loans; preserve insurance against inability to repay. - Use targeted conditional cash assistance to disadvantaged students and condition on education outcomes. ### Wealth and property taxation - Wealth taxes: - Effective tax rate on wealth-related taxation dropped from around 0.9 percent in 1970 to approximately 0.5 percent today. - Recurrent property taxes are equitable and efficient but underutilized: average yield in 65 economies in the 2000s was around 1 percent of GDP; in developing economies average yield is only half of that. - Countries outside advanced economies collecting more than 1 percent of GDP via recurrent property taxes include Colombia, Namibia, Russia, South Africa, and Uruguay. - Recurrent net-wealth taxes generally raise little revenue due to mobility and evasion; better information exchange could improve prospects. - Inheritance/gift taxes and transaction taxes: - OECD inheritance revenue declined from 0.35 percent of GDP in 1970 to less than 0.15 percent today; France at 0.4 percent of GDP and Belgium at 0.65 percent of GDP are higher-yield examples. - Transaction taxes are administratively appealing but can be economically distortive; distributional impact unclear. - Consumption taxation (VAT and excises) recommendations: - Consumption taxes are generally inferior for redistribution to income taxes/transfers. - Minimize exemptions or reduced VAT rates; elimination of reduced VAT rates combined with expanded social benefits can be pro-poor (example: United Kingdom). - Where capacity to deliver transfers is weak, limited VAT differentiation on basic food may be justified. - Set sufficiently high VAT registration thresholds to ease compliance burdens on small traders. - Use excises mainly for corrective purposes (cigarettes, alcohol, carbon) rather than as redistribution tools. ### Fiscal consolidation: mechanisms, evidence, and design principles - Mechanisms by which consolidation can affect inequality: - Short-run: reductions in output and employment; decline in wage share; unskilled wages fall relative to skilled wages. - Long-run: potential harm to supply side via human capital loss from long-term unemployment. - Composition and pace matter: - Inequality tends to increase more when adjustment relies on raising regressive taxes and cutting progressive spending. - Spending-cut-based consolidations tend to worsen inequality more than revenue-based ones. - Frontloaded adjustments during high unemployment can have stronger welfare costs. - Evidence from recent episodes: - In about half of 27 recent adjustment episodes, market income inequality increased during fiscal consolidations. - In almost two-thirds, fiscal measures led to either a decrease in inequality (decline in disposable income Gini) or at least partly offset worsening market inequality. - Country simulations (2008–12) report average effects on disposable incomes (simulated impacts, averages preserved exactly where given): - Greece: Average: -11.6 - Portugal: Average: -6.3 - Estonia: Average: -4 - Spain: Average: -4.3 - Italy: Average: -1.6 - Lithuania: Average: -2.8 - Romania: Average: -5.7 - UK: Average: -1.9 - Latvia: Average: -9.1 - Example outcomes: - Ireland (2009–12): bottom 10 percent incomes decreased by about 5 percent; top 10 percent incomes decreased by about 13 percent. - Cyprus (2012): bottom 20 percent incomes reduced by 0.1 percent; top 20 percent by 2 percent. - Distributional patterns of common consolidation measures: - Public sector wage reductions often progressive where public employees are relatively high-income. - Cuts in untargeted benefits largely progressive; reductions in means-tested benefits regressive. - Proportional pension reductions across beneficiaries strongly regressive unless targeted to high pensions. - Increases in VAT rates are regressive; degree depends on VAT structure and consumption patterns. ### Designing progressive fiscal adjustments (policy recommendations) - During fiscal adjustment governments could: - Protect the most progressive and efficient redistributive spending. - Improve targeting to minimize inequality effects. - Broaden spending cuts toward subsidies, military spending, and public sector wages to reduce need for cuts in social transfers. - Rely more on progressive revenue measures where feasible (reductions in regressive tax expenditures; greater taxation of wealth and property). - Expand active labor market programs to accelerate unemployment decline as growth resumes (job-search support, targeted wage subsidies, training). - Pace of adjustment should reflect the state of the economy, public finances, and market pressures; composition determines progressivity. ### Appendices and supplementary evidence highlights - Appendix I: tax incentives for charitable giving—country practices and distributional issues; U.S. donations in 2010 totaled US$291 billion—1.9 percent of GDP. - Appendix II: recent fiscal consolidations and income inequality (nine European countries, 2008–12)—country-level decompositions show variation in measures and distributional outcomes. *Source: _012314 - EXECUTIVE SUMMARY — January 22, 2014.* ### EXECUTIVE SUMMARY ### _012314 - EXECUTIVE SUMMARY ### Overview - Fiscal policy is the primary tool for governments to affect income distribution. - Rising income inequality in advanced and developing economies has coincided with growing public support for income redistribution, at a time when fiscal restraint is an important priority in many economies. - This paper describes: (i) recent trends in the inequality of income, wealth, and opportunity in advanced and developing economies; (ii) country experience with different fiscal instruments for redistribution; (iii) options for reform of expenditure and tax policies to help achieve distributive objectives in an efficient manner consistent with fiscal sustainability; and (iv) recent evidence on how fiscal policy measures can be designed to mitigate the impact of fiscal consolidation on inequality. - The paper does not advocate any particular redistributive goal or policy instrument. ### Key findings on trends and macroeconomic context - Income inequality has increased in both advanced and developing economies in recent decades. - Factors attributed to rising inequality include globalization and liberalization of factor and product markets; skill-biased technological change; increases in labor force participation by low-skilled workers; declining top marginal income tax rates; increasing bargaining power of high earners; and the growing share of high-income couples and single-parent households. - There is growing evidence that high income inequality can be detrimental to the pace and sustainability of growth and possibly related to financial vulnerabilities. - Public demand for redistribution has risen, especially in countries strongly affected by the crisis, while high public debt ratios in advanced economies and emerging vulnerabilities in developing economies have made fiscal restraint an important priority. - Fiscal policy affects distribution both directly (income taxes and cash transfers affecting disposable income) and indirectly (in-kind benefits such as education and health affecting future market incomes). ### Fiscal instruments and country experience - Both tax and expenditure policies need careful design to balance distributional and efficiency objectives, including during fiscal consolidation. - The appropriate mix of instruments depends on administrative capacity, society’s preferences for redistribution, the role envisaged for the state, and political economy considerations. - The paper draws on country experience and IMF technical assistance reports to identify options that achieve distributional objectives at minimum efficiency cost. ### Recommended options to minimize efficiency costs (as stated) - In advanced economies: - using means-testing, with a gradual phasing out of benefits as incomes rise to avoid adverse effects on employment; - raising retirement ages in pension systems, with adequate provisions for the poor whose life expectancy could be shorter; - improving the access of lower-income groups to higher education and maintaining access to health services; - implementing progressive personal income tax (PIT) rate structures; and - reducing regressive tax exemptions. - In developing economies: - consolidating social assistance programs and improving targeting; - introducing and expanding conditional cash transfer programs as administrative capacity improves; - expanding noncontributory means-tested social pensions; - improving access of low-income families to education and health services; and - expanding coverage of the PIT. - Innovative approaches that could be considered in both advanced and developing economies include greater use of taxes on property and energy (such as carbon taxes). ### Design principles and efficiency considerations - The objective is to identify fiscal instruments that achieve distributional goals at minimum cost to economic efficiency (understood as increases in the aggregate level or growth of income, and reductions in deadweight loss). - There may be instances where equity and efficiency can be jointly improved (for example, social insurance encouraging risk-taking, redistribution relaxing credit constraints and boosting human capital). - Trade-offs between equity and efficiency become inevitable once mutually beneficial possibilities are exhausted; the paper focuses on options that minimize such trade-offs. ### Fiscal consolidation and distributional sensitivity - Given the need for fiscal consolidation in many countries, designing consolidation packages requires sensitivity to distributional concerns. - Fiscal consolidation can affect inequality in both the short run (through output and employment effects) and the long run (through channels described earlier, such as impacts on human capital and market incomes). - The paper examines recent evidence on how fiscal policy measures can be designed to mitigate the impact of fiscal consolidation on inequality. *Source: _012314 - EXECUTIVE SUMMARY — January 22, 2014.* ### 9. Over the last three decades, inequality in the personal distribution of income has ### _012314 - 9. Over the last three decades, inequality in the personal distribution of income has ### Trends in personal income inequality (1980–2010) - The Gini coefficient ranges between 0 (complete equality) and 1 (complete inequality). - Between 1990 and 2010, the Gini for disposable income increased in nearly all advanced and emerging European economies. - Over one-third of advanced economies and half of emerging Europe experienced increases in their Ginis exceeding 3 percentage points, with most increases in emerging Europe occurring between 1990 and 1995. - Inequality also rose in most economies in Asia and the Pacific and in Middle East and North Africa. - Average inequality fell in sub-Saharan Africa over this period, but it still rose by more than 3 percentage points in more than one-fourth of these economies. - Inequality increased in over one-third of economies in Latin America, although on average there was a slight decline. - Since 2000 there has been a substantial decline in the Gini in nearly all countries in a given region (textual statement). ### Regional differences and fiscal policy - Between 1990 and 2010, average inequality in each region changed by less than 3¼ percentage points. - Average inequality in the two most unequal regions (sub-Saharan Africa and Latin America) remained 12 percentage points higher than the two most equal regions (emerging Europe and advanced economies). - A large proportion of differences in regional average disposable income inequalities can be explained by differences in fiscal policies, especially in the levels and composition of taxes and spending. ### Rising shares at the top of the distribution - Over the last three decades market income shares of the richest one-percent have increased substantially in English-speaking advanced economies, as well as in China and India. - United States example: - Share of market income captured by the richest 10 percent: around 30 percent in 1980 to 48 percent by 2012. - Share of the richest one-percent: 8 percent in 1980 to 19 percent by 2012. - Share of the richest 0.1 percent: 2.6 percent in 1980 to 10.4 percent by 2012. - Increases in the share of the top one-percent have been much less pronounced in Southern European and Nordic economies, and hardly any increases have been observed in continental Europe and Japan. ### Public support for redistribution (Box 2) - Surveys used: World Value Surveys (WVS), Regional Barometers, International Social Surveys; Integrated Values Survey 1981–2008 cited. - Survey coding: WVS scale 1–10 where 1 = “incomes should be made more equal” and 10 = “needs larger income differences as incentive”; responses 1–5 coded as support for more redistribution, 6–10 as support for less. - Between the late-1990s and the late-2000s, public support for redistribution increased in almost 70 percent of advanced and developing economies surveyed. - In the late-1990s, 15 economies out of 57 (26 percent) showed majority support for more redistribution; by the late-2000s this rose to 56 percent of countries. - Support for redistribution grew more in countries where inequality increased; example: public support grew by more than 30 percentage points in China, Finland, Germany and several Eastern European countries where the income Gini increased by over 20 percent. - Between 2008 and 2011, among advanced economies, public opinion shifted more in favor of redistribution in countries that experienced large declines in GDP (examples: Portugal, Ireland, Slovenia). ### Poverty trends in developing economies - Poverty measure: absolute poverty as percentage of population below $1.25 per capita per day in 2005 PPP dollars. - Sub-Saharan Africa: sustained economic growth and declining average inequality led to a substantial and sustained decline in absolute poverty rates. - Asia and the Pacific: high growth produced even larger decreases in absolute poverty despite rising average inequality. - Absolute poverty also trended downward in Latin America and the Caribbean and in the Middle East and North Africa since the mid-1990s. ### Inequality of wealth - In advanced economies, household net wealth increased substantially over the last four decades (data limited). - Comparable data for eight large advanced economies: average ratio of net household wealth to national income grew by almost 80 percent between 1970 and 2010. - Italy: largest increase by 180 percent. - United States: smallest increase by 21 percent. - Wealth is more unequally distributed than income: - Sample of 26 advanced and developing economies in the early 2000s: wealth Gini = 0.68, disposable income Gini = 0.36. - Share of wealth held by the top 10 percent: - Slightly less than half in Chile, China, Italy, Japan, Spain, United Kingdom. - More than two-thirds in Indonesia, Norway, Sweden, Switzerland, United States. - Switzerland and United States: top one-percent alone holds more than one-third of total household wealth. - Rising wealth inequality examples: - Canada and Sweden (mid-1980s to early-2000s): growth of wealth concentrated in the two upper deciles. - Finland and Italy: wealth Gini rose from around 0.55 to above 0.6 between mid-1980s and early-2000s. - United States: wealth Gini rose from 0.80 in the early-1980s to almost 0.84 in 2007. - Non-financial assets share: - Survey data: non-financial assets represent between 70 and 90 percent of total household gross wealth in advanced economies. - In developing economies (early 2000s): non-financial asset share exceeded 90 percent in India and Indonesia. - Financial vs non-financial wealth inequality: - Fredriksen (2012): average Gini for financial wealth ≈ 0.8 for seven advanced countries; Gini for non-financial wealth ≈ 0.63. - Administrative data note: Eyraud (2013) reports financial wealth is between 60 and 70 percent of total gross wealth in Japan, Switzerland, United States, whereas survey data for these countries suggest a share well below 50 percent. ### Lifetime inequality - Lifetime inequality is usually lower than inequality in any given year for two reasons: 1. Year-to-year earnings mobility reduces lifetime dispersion (Bowlus and Robin (2012)): lifetime inequality about 20–30 percent lower than annual income inequality in Canada, the United Kingdom, and the United States. 2. Age-income cycle: incomes lower in early working years, peak in later years, then decline (Paglin, 1975). - Sweden: Björklund (1993) finds dispersion of lifetime income is about 35–40 percent lower than annual income. - Lifetime income inequality matters for assessing redistributive effects of social insurance contributions and benefits. ### Inequality of opportunity and intergenerational mobility - Restricted opportunities (education, access to professions/business) reinforce persistence of income inequality across generations (OECD, 2011a; Corak, 2013). - Intergenerational earnings mobility (elasticity between parent’s and offspring’s earnings) is: - Low in Italy, United Kingdom, United States (high disposable income Ginis). - Much higher in Nordic countries. - The “Great Gatsby Curve”: countries with high income inequality around 1985 (high Gini coefficients) had high intergenerational earnings elasticities. - In low-mobility countries, about 50 percent of any economic advantage a father has is passed onto his offspring; in high-mobility countries this falls to less than 20 percent. - In developing economies with data, income mobility is extremely low, especially in high-inequality economies of Latin America. - Chetty and others (2013): intergenerational income mobility varies substantially throughout the United States, especially low in southern states. ### Evaluating fiscal redistribution - Redistributive impact assessment compares incomes after taxes and transfers with counterfactuals without them. - Full incidence analysis should account for behavioral responses to taxes and transfers and impacts on market incomes, but most empirical studies do not incorporate behavioral responses due to data limitations. - Common incidence assumptions in such studies: - Commodity taxes assumed to fall on consumers. - Factor taxes assumed to fall on factor suppliers (labor and capital). - Transfers to beneficiaries assumed not to change factor supplies. - Critiques and alternative approaches cited: Kotlikoff and Summers (1987); Boadway and Keen (1993); Whalley (1984); Dilnot, Kay, and Keen (1990). - Econometric studies that capture behavioral responses are summarized elsewhere (Box 3 referenced). *International Monetary Fund (excerpt).* ### Box 3. Redistributive Fiscal Policy: Evidence from Regression Analysis ### Box 3. Redistributive Fiscal Policy: Evidence from Regression Analysis ### Regression-based approaches: scope, strengths, and limitations - Regression-based models typically regress the disposable income Gini coefficient on variables capturing the composition of taxes and spending, with control variables for other factors affecting income distribution. - Strengths noted: - Can provide estimates without assumptions on compliance and take-up rates. - Can capture general equilibrium effects of taxes and transfers. - Key methodological and data challenges: - Data may not be fully comparable across countries or over time. - Estimation methods may not adequately address endogeneity of fiscal variables and omitted variable bias. - Results and interpretation are sensitive to model specification and data sources. - Implicitly assume similar design of taxes and transfers across countries, potentially obscuring the importance of program design for incidence. ### Main findings from regression-based studies - Broad empirical regularities: - Greater reliance on income taxes and higher spending on social benefits reduces inequality. - Direct taxes are more redistributive than indirect taxes. - Social protection spending reduces inequality. - Nuanced findings: - Higher spending on targeted social benefits (such as means-tested social assistance) does not always reduce inequality; possible behavioral responses include withdrawal from the labor market. - Emphasizes importance of designing benefits so they do not discourage work effort. - Studies cited as sources: Chu, Davoodi, and Gupta (2004); Niehues (2010); Ospina (2010); Martínez-Vázquez, Vulovic and Moreno-Dodson (2012); Muinelo-Gallo and Roca-Sagles (2013); and Woo and others (2013). ### A. Advanced Economies — empirical evidence and patterns - Aggregate impact: - Direct income taxes and transfers decreased inequality in advanced economies by an average of one-third (mid-2000s). - Example: in 2005, the average Gini for disposable income was 14 percentage points below that of the average market income Gini. - The redistributive impact of transfers accounts for about two-thirds of the decrease in the Gini. - Within transfers, non-means-tested transfers (including public pensions and family benefits) account for the bulk of redistribution. - Taxes: - Personal income taxes make an important contribution; in most economies, redistribution achieved through income taxes is even higher than for means-tested transfers. - Lifetime perspective: - Social insurance and other transfers are far less redistributive when examined from the perspective of lifetime income. - Example: Bovenberg, Hansen, and Sorenson (2012) show about three-fourths of redistribution in Denmark involves redistribution over peoples’ lifecycle rather than from lifetime rich to lifetime poor; similar magnitudes reported for Australia, Ireland, Italy, and Sweden. - Trends over time: - Between the mid-1980s and mid-1990s: - Market income Gini increased by 3.1 percentage points. - Disposable income Gini increased by 1.1 points. - Fiscal policy offset about two-thirds of the increase in market income inequality over this period. - Between mid-1990s and mid-2000s: - Market income inequality increased by 2.2 percentage points. - Disposable income inequality increased by 1.8 percentage points. - Fiscal policy offset less than half of the increase in market inequality over the two decades from mid-1980s to mid-2000s. - The reduction in redistributive power since the mid-1990s attributed to fiscal reforms that reduced generosity of unemployment and social assistance benefits and reduced income tax rates, especially at higher income levels. - Corporate taxes: - Evidence on effects of reductions in corporate income taxes on inequality is mixed. - Long-run incidence depends on relative mobility of capital and labor; taxation of “rents” likely falls on owners of capital. - Recent empirical evidence suggests between 45 and 75 percent of the corporate tax burden falls on wages. - Implication: corporate income taxes may not be as progressive over the longer term as often believed. - Indirect taxes and in-kind transfers: - Indirect taxes tend to be regressive or proportional; both VAT and excise duties are regressive, with excise taxes especially regressive. - Regressivity of indirect taxes is typically much smaller when assessed against lifetime income or consumption. - In-kind transfers (education and health) are very progressively distributed: - On average, in-kind transfers decrease the Gini coefficient by 5.8 percentage points in five European economies (Belgium, Germany, Greece, Italy, United Kingdom). - Health accounts for 3.6 points and education for 2.2 points of this impact. - Expansion of access at lower levels can decrease earnings inequality in the medium term. ### B. Developing Economies — constraints and distributional patterns - Evidence base: - Much less evidence on overall distributional incidence in developing economies; Latin America is an exception with more comprehensive studies. - Scale of fiscal instruments: - Low levels of both taxes and social spending limit redistributive impact. - Average tax ratios: advanced economies exceed 30 percent of GDP; developing economies (excluding emerging Europe) generally fall in the range of 15–20 percent of GDP. - Lower social spending implies substantially reduced redistributive effects. - Example: differences in redistributive impact of tax and spending can explain two-thirds of the difference in disposable income Gini between Latin America and advanced economies. - Composition and coverage: - Developing economies allocate a relatively smaller proportion of social spending to social transfers, especially low-income countries in Asia and Pacific and in sub-Saharan Africa. - Low coverage of low-income groups diminishes redistributive impact, with most benefits going to higher-income groups. - In Latin America and the Caribbean, high coverage reflects extensive social assistance programs, but benefits tend to be low, so the poor still receive a low share of total social transfers. - In-kind spending incidence: - Distribution of public spending on education and health is often regressive in many developing economies due to lack of access by low-income households. - Incidence varies by category: - Primary health care spending is progressive; higher-level health spending is regressive. - Primary education spending is progressive; secondary and tertiary education spending are regressive. - Policy implication: “extensive expansion” to increase access to basic education and health is likely to be much more progressive than current spending and can reduce income inequality over the medium term. ### Design of efficient redistributive fiscal policy — conceptual framework and principles - Overarching objective: - Achieve distributional objectives at minimum efficiency cost while maintaining fiscal sustainability. - Optimal spending considerations: - Optimal level of spending where marginal social benefit equals marginal social cost of financing. - Optimal redistributive spending varies by country depending on preferences and costs (including efficiency costs of taxation). - Benefits of redistributive spending should be compared with alternative uses (e.g., public infrastructure supporting growth). - Redistributive policy should be consistent with fiscal sustainability to support growth and capacity to finance higher redistribution over time. - Instrument choice and targeting: - Direct instruments based on income are generally more efficient for redistribution (e.g., personal income taxes preferred over consumption taxes; cash transfers superior to price subsidies). - Better targeting of transfers reduces fiscal cost and tax requirements, achieving distributional objectives more efficiently. - Targeting carries efficiency costs and must be designed carefully to avoid adverse incentives. - Joint evaluation: - Tax and expenditure policies should be evaluated jointly because trade-offs between efficiency and redistribution differ across instruments. - Where efficiency cost of redistribution through taxes is large, those taxes may best focus on raising revenue to finance highly progressive public expenditures. *Source: Box 3, "Redistributive Fiscal Policy: Evidence from Regression Analysis" (extracted content).* ### 34. Both tax and expenditure policies need to be carefully designed to balance ### 34. Both tax and expenditure policies need to be carefully designed to balance ### Principles for designing tax and expenditure policy to minimize efficiency costs - Use means-tested cash transfers where possible while minimizing adverse labor market incentives. - Means-tested programs restrict eligibility or benefit levels according to income and can achieve redistributive objectives at a lower cost than benefits provided to the entire population. - Implement means-tested programs to avoid adverse labor market effects, for example, by gradually phasing out benefits as incomes rise. - Note: In a minimum income scheme where the transfer equals the difference between an individual’s income from work and the poverty line, the implicit marginal tax rate on work is 100 percent; a more gradual phasing out reduces disincentives but lowers fiscal savings from means-testing. - Exception: In countries with a strong preference for universal benefits and the capacity to raise high levels of revenues in an efficient manner with broad popular support, means-testing may not be socially optimal. - Use tagging where means testing is not feasible. - Tagging links transfers to characteristics strongly correlated with income (e.g., age, geographic location). - The stronger the correlation with income or other characteristics of need, the lower the fiscal cost of achieving a given amount of redistribution. - Tags are imperfectly correlated with need, causing undercoverage of the poor and leakage to the non-poor; additional transfer programs may be needed to protect excluded poor. - Tags should not be easily manipulated and should be easily verifiable. - Make income taxation progressive. - Tax schedules should entail higher tax rates for upper-income groups than for those in the middle of the income distribution (see Box 5). ### Box 5 — Shape of the optimal income tax schedule (summary of findings) - Optimal marginal tax structure (Mirrlees framework, Diamond, Saez): - Typical U-shaped pattern: high at the bottom, low for middle incomes, high at the top. - High marginal rates at the bottom reflect means testing (gradual phasing out of cash transfers, negative income taxes) to target lowest incomes and allow lower marginal rates elsewhere. - Middle-income marginal rates should be lower because density in income distribution is generally high and high marginal rates would impose large aggregate distortions. - Top marginal rates rise again as density falls and redistributive gains dominate efficiency costs. - Corollary: Flat personal income tax (PIT) structures are generally not the most efficient way to organize redistribution. - Earned income tax credit / in-work benefits: - Reduces tax rates for low-income workers; can relieve very low labor incomes from paying tax or pay a net subsidy (negative income tax). - Improves efficiency where discrete participation distortions exist (choice to participate in labor market). - Evaluations generally positive in several advanced countries (see Box 6). - Optimal top PIT marginal tax rate: - Revenue-maximizing estimates generally range between 50 and 60 percent (IMF, 2013b). - Piketty, Saez, and Stantcheva (2011) argue it may be up to 80 percent under the extreme assumption of zero welfare weight for the very rich. - If a positive welfare weight is assigned to top earners, the optimal top PIT rate will be lower and left from the top of the Laffer curve. ### Indirect taxes and revenue-raising - Design indirect taxes to raise revenue efficiently: - Make broad-based consumption taxes uniform and avoid differential rates across goods and services to improve administrative and compliance efficiency. - Revenues from broad-based consumption taxes can finance progressive spending. - Reduced rates are generally ineffective at targeting support to the poor; eliminating reduced rates and expanding even moderately progressive spending can be pro-poor (Keen, 2014). - The case for reduced rates is strongest where capacity to deliver public transfers to the poor is very weak. ### Equality of opportunity, administrative capacity, and labor-market interactions - Fiscal policy can promote equality of opportunity and intergenerational mobility: - Spending focused on access to education and health enhances social mobility, breaks inter-generational transmission of poverty, and increases progressivity of public spending. - Improved education and health for lower-income groups lowers future income inequality and reduces future need for redistributive taxes and transfers. - Appropriate mix of direct and indirect instruments depends on administrative capacity: - Effective direct cash transfers and taxes require access to information on individual incomes and administrative capacity to process, collect, and pay benefits. - Where capacity is limited (many developing economies), indirect instruments (tagging, progressive indirect taxes) may be needed. - Emerging economies generally have a wider feasible range of options—especially on expenditure—than low-income economies. - Compare fiscal instruments with labor market regulations: - Minimum wages and employment protection impose economic costs on the private sector; the impact of minimum wages on inequality is ambiguous due to offsetting effects on wage dispersion and employment. - Minimum wages are blunt instruments: benefits may accrue to non-poor households with low-wage workers. - Given uncertainty around wage and employment regulation effects, fiscal instruments (e.g., well-designed in-work social benefits) are often superior for redistributive goals. - Redistributive fiscal policies should be considered with labor-market regulations: in-work benefits can increase labor supply and reduce low-skilled wages, shifting some benefit incidence to employers when minimum wages are low and not binding. ### Box 6 — In-work benefits and credits (key points) - Purpose and design: - Stimulate labor force participation and provide income support to low-income groups; often tax credits that constitute net transfers when exceeding tax liabilities. - Increase net income gain from accepting a job versus being out of work; usually phased out as incomes rise. - Phase-out steepness depends on emphasis: gradual phase-out favors labor force participation; steep phase-out focuses on limiting leakage to higher-income families. - Minimum hours requirements can avoid support to high-skilled part-time workers. - Steep phase-outs cause high marginal tax rates and adverse labor supply effects. - Empirical evidence: - Positive net employment effects in the United Kingdom and the United States, especially for single women with children. - Negative labor supply effects within the phase-out range are small; aggregate effect on labor supply is quite small. - Administrative considerations: - Most appropriate where tax administration is strong (withholding system, taxpayers filing returns); administration costs small in such contexts. - Costs substantial if low-wage earners do not file returns, withholding systems are weak, or schemes extend to self-employed. - Ensure other means-tested benefits do not offset positive work incentives; self-assessment-based credits can face non-compliance and false claims. - Given administration requirements and potentially large fiscal costs, in-work benefits are unlikely viable for many developing economies. ### Social spending and pensions (advanced and developing economies) - Overview: - Social spending (social protection, education, health) is the primary instrument for redistributive goals. - Efficiency gains from social spending come from improving targeting and reducing adverse labor market effects. - Design features vary across advanced and developing economies depending on fiscal and administrative capacities. - Advanced economies — pension considerations: - Pension benefits account for about two-thirds of social protection spending. - Without reforms, average pension spending is projected to rise by an additional 1½ percent of GDP by 2030. - Pensions provide lifetime consumption smoothing and account for over half of total redistributive impact of social transfers. - Reform options to preserve redistributive role while containing spending growth: - Increase the effective retirement age: - Gradual increases reduce need for other reforms that lower benefits and risk raising old-age poverty. - Because lower-income groups have shorter life expectancy, increasing retirement age reduces their lifetime pension benefits proportionally more—mitigate by linking eligibility to years of contribution rather than a single statutory age. - Accompany increases with measures to enhance earning opportunities for older, low-skilled workers (labor protections, retraining, adult education). - Protect older workers via disability pensions and social assistance; reduce incentives for early retirement; reduce disincentives to work beyond statutory age (e.g., concessional contribution rates, in-work benefits). - Incorporate pension incomes into a progressive income tax system: - Many countries give pensions favorable tax treatment; equalizing treatment across income sources can reduce net fiscal cost and lower inequality. - Countries subsidizing private pensions through tax relief or matching contributions should consider scaling back, since benefits accrue mostly to high-income groups and have little impact on national savings. - Make benefit cuts progressive: - Parametric reforms often reduce replacement rates over time; reductions should be progressive to avoid increasing elderly poverty. - Progressive cuts require larger reductions for higher-income groups and may involve trade-offs with consumption smoothing and compliance concerns. - Where lower-income benefit cuts are unavoidable, ensure access to other social benefits or implement means-tested social pensions financed from general revenues. - Developing economies — pension considerations: - Reforms should prioritize sustainability of existing systems and consider expanding noncontributory social pensions. - Small redistributive impact of public transfers in many developing economies reflects limited pension coverage and skew toward higher-income formal sector and public sector workers. - Regressive financing: many pension systems require significant general revenue financing, reducing net redistributive impact. - Priority: parametric reforms to put systems on sound financial footing to free resources for noncontributory social pensions (flat pensions aimed at poverty reduction). - Social pensions exist in emerging and low-income countries (examples cited in source). - Cost of social pensions can be substantial at about ½–¾ percent of GDP. - To contain costs, consider means-testing. ### Selected numeric facts and estimates preserved exactly as in source - Pension benefits account for about two-thirds of social protection spending. - Average pension spending is projected to rise by an additional 1½ percent of GDP by 2030. - Cost of social pensions can be substantial at about ½–¾ percent of GDP. - South Africa’s Social Grants Program includes a means-tested social pension program costing 1.3 percent of GDP. - Estimates of the revenue-maximizing top PIT rate generally range between 50 and 60 percent. - Piketty, Saez, and Stantcheva (2011) argue it may be even higher—up to 80 percent—under extreme assumptions. - In some evaluations, 70 cents per dollar spent on the earned income tax credit ultimately benefits employers by reducing their labor costs. - CBO (2014) indicates that 19 percent of the benefits from raising the minimum wage in the United States would accrue to families below the poverty line, and 29 percent to families with incomes three times the poverty line. *International Monetary Fund — excerpted content from the supplied PDF chapter/section.* ### 0.7 percent of GDP in Madagascar to 2.4 percent of GDP in Ethiopia. Limiting the pension to only the elderly poor ### _012314 - 0.7 percent of GDP in Madagascar to 2.4 percent of GDP in Ethiopia. Limiting the pension to only the elderly poor ### Pensions and targeted elderly allowances - Pension expansion to cover elderly poor: cost examples range from "0.7 percent of GDP in Madagascar to 2.4 percent of GDP in Ethiopia." - Limiting the pension to only the elderly poor "would approximately halve this cost for most countries." ### Family benefits: redistribution and labor-market incentives - Finding: "On average, in 2005, family benefits decreased the disposable income Gini by nearly 1.5 percentage points, accounting for nearly three-quarters of the redistributive impact from total social assistance spending." - Typical family benefit types: paid maternal/paternal leave, child allowances, childcare benefits. - Policy recommendations: - Means testing and conditioning of child benefits: - Rationale: "High child allowances reduce incentives for women to enter the labor market with detrimental effects for future earnings prospects." - Mechanisms: link benefits to labor force participation (including childcare subsidies and child tax credits); expand means testing and include benefits in taxable income within a progressive tax schedule. - Evidence: "the very small share of these benefits that is currently means tested (Figure 11)." - Reduce maximum duration of paid parental leave where very long: - Evidence: "Jaumotte (2003) found that parental leave has a positive effect on female labor supply up to a limit (20 weeks with full replacement of earnings), above which the marginal effect of further leave becomes negative." - Capping earnings-related leave can increase progressivity. - Key statistics from family benefits (2010 / 2010 spending figure): - "Average total spending = 2.2%" - "Average non means-tested spending = 1.8%" ### Active labor market programs (ALMPs) and in-work benefits - Problem: Guaranteed minimum income programs can create strong work disincentives when benefits are withdrawn as employment increases. - Policy recommendations: - Strict conditioning of eligibility on participation in ALMPs: - Components: personal employment services, training, job placement, public employment schemes. - Design: intensity of activation should increase with unemployment duration. - Greater use of in-work benefits: - Rationale: allow gradual withdrawal of benefits as earnings or employment duration increase; reduce the net tax on additional earnings. - Caution: containing fiscal cost requires more rapid withdrawal as incomes increase, which may create disincentives further up the income distribution. ### Shortcomings and reforms for social assistance in developing economies - Common shortcomings: - Fragmentation and duplication across multiple small programs and ministries. - Bad targeting: weak tagging correlated with poverty leads to large leakage to non-poor households. - Example: "if social assistance benefits were restricted to those in the bottom 40 percent of the income distribution, the median fiscal savings would be approximately 0.4 percent of GDP." - Staff estimate details: "The median share of social assistance transfers accruing to the bottom 40 percent of the income distribution is 46 percent, while the median level of social assistance spending was 0.76 of a percent of GDP. Eliminating all leakage of benefits to the top 60 percent of the income distribution (i.e., 54 percent of total spending) would therefore reduce spending by 0.41 percent of GDP." - Low coverage and low benefit levels: - "The savings from better targeting of benefits (see bullet above) could be used to expand coverage from the present median of 38 percent to 82 percent." - Reliance on costly in-kind benefits with high overheads (overhead costs can be "as much as 50 percent higher than the value of the in-kind benefit to beneficiaries"). - Reliance on universal price subsidies: - "In sub-Saharan Africa, for example, spending on energy subsidies in 2011, on a post-tax basis, equaled 3½ percent of GDP, and in the MENA region, 14½ percent of GDP." - Distributional skew: "the richest 20 percent of the population reaps about 43 percent of the benefits from energy subsidies in developing economies, while the poorest 20 percent receive 7 percent." - Policy recommendations: - Consolidate benefits into a smaller number of programs with clear objectives to reduce administrative fixed costs. - Improve targeting and scale down price subsidies to enhance poverty impact and create fiscal space for expanded, effective safety nets. - Use savings to finance more effective safety net programs with expanded coverage and adequate benefit levels. - Implementation note: reforms are especially important where social assistance spending is low and must compete with growth-enhancing spending (education, health, infrastructure). ### Conditional Cash Transfer (CCT) programs - Suitability: "Means-tested conditional cash transfer (CCT) programs could be expanded as a tool to achieve distributional objectives in developing economies as administrative capacity improves." - Typical CCT features: - Targeting based on number, age, and gender of children; selection often via "proxy means tests" producing household poverty scores. - Continued eligibility typically over a three year period conditioned on school and health clinic attendance. - Often financed by scaling down universal price subsidies and consolidating programs. - Impacts and costs: - Examples: Brazil (Bolsa Familia) and Mexico (Oportunidades) in 2012 cost "0.5 percent of GDP and 0.8 percent of GDP and covered one-quarter and one-fifth of the population, respectively." - Effects: "substantial impacts on poverty and inequality, as well as education and health outcomes"; direct impact in Brazil and Mexico "accounts for one-fifth of the decrease in the Gini between 1995 and 2004 in these two countries." - Limitations and implementation requirements: - Require adequate administrative capacity to implement means-testing and monitor conditionality. - Require that targeted poor populations have access to basic education and health services. - More suitable initially for emerging than low-income economies; many low-income countries adopt pilots before national expansion. ### Public works programs in developing economies - Role: address persistent or seasonal poverty and protect households from income shocks. - Design features for cost-effectiveness: - Encourage self-selection of the poor by setting wages below prevailing market wages for unskilled labor. - Time programs to avoid peak employment seasons (e.g., agricultural harvests) to prevent crowding out private sector jobs. - Emerging economies with greater administrative capacity can add infrastructure and training components to enhance developmental impact. ### Unemployment benefits: design to strengthen take-up of employment - Role: protect individuals from income loss due to transitory or structural unemployment. - Design features to improve incentives and reduce fiscal cost: - Strict eligibility criteria (e.g., past employment/contributions, mandatory ALMP participation). - Short duration: "About a third of OECD countries have a maximum duration in excess of 12 months." - Declining benefit levels with unemployment duration to encourage return to work. - Individual unemployment savings accounts (ISAs): - Link contributions to benefits; individuals draw from accounts during unemployment; once exhausted, can borrow from government at same interest rate. - Used in a number of emerging economies, including Brazil and Chile. *International Monetary Fund, "Fiscal Policy and Income Inequality" (excerpts).* ### 48. Education reforms in both advanced and developing economies could focus on ### 48. Education reforms in both advanced and developing economies could focus on improving access by low-income groups ### Education: findings and policy recommendations - Finding: The regressive benefit incidence of education spending in developing economies reflects lower access by low-income groups to higher levels of education (including upper secondary and tertiary education). - Finding: In advanced economies, although education spending as a whole is progressive, tertiary education spending tends to be regressive. - Finding: Lack of access to education in both developing and advanced economies results in inequality of opportunity and perpetuates inequality across generations. - Recommendation: Increasing investment in lower levels of education. - Rationale: The main driver behind the regressivity (or lower progressivity) of public education spending is the large share of the budget allocated to higher levels of education, which are disproportionately accessed by higher income groups. - Developing-economy focus: Improve access to and progression through primary and lower-secondary education, especially for girls and in rural areas. - Advanced-economy focus: Improve access to, progression through, and performance in higher-secondary and tertiary education. - Cross-country priority: Increase access to early childhood education in both advanced and developing economies given substantial evidence of crucial impact on later educational performance. - Recommendation: Improvements in the efficiency of education spending. - Rationale: Inefficiencies in spending are substantial, including in low-income economies (Gupta and others, 2007; Grigoli, forthcoming). - Policy: Complement increased spending at lower levels with efforts to get better results from existing levels of spending. - Recommendation: Increased cost recovery in tertiary education. - Rationale: Demand for tertiary education has increased rapidly in both advanced and developing economies, often faster than public financing capabilities, resulting in a decline in quality of instruction in public institutions and growth in private institutions (Woodhall, 2007; OECD, 2011b). - Policy options: Financing more of tertiary cost from tuition fees; income-contingent student loans to cover tuition and subsistence costs so students begin paying once they start earning, ensure higher education is free at point of use, and provide insurance against inability to repay due to low future income (Barr, 2012). - Benefit: Increasing private financing allows tertiary education to expand without increasing public spending. - Recommendation: Targeted conditional cash assistance. - Policy: Target cash assistance to those with disadvantaged access and condition on education outcomes to reduce barriers and incentivize achievement. - Note: This “conditional cash transfer” strategy is being increasingly used in both advanced and developing economies (Box 7). - Complementary reforms: Targeted information campaigns and increasing availability of shorter term qualification options. *Italicized attribution line.* ### 54. Some taxes levied on wealth, especially on immovable property, are also an option for ### _012314 - 54. Some taxes levied on wealth, especially on immovable property, are also an option for ### Wealth taxes and their redistributive role - Wealth taxes target the same underlying base as capital income taxes (assets) and can be a source of progressive taxation where taxes on capital incomes (including on real estate) are low or largely evaded. - Types of wealth taxes discussed: recurrent taxes on property or net wealth, transaction taxes, and inheritance and gift taxes. - Revenue from wealth taxes has not kept up with the surge in wealth as a share of GDP: - Effective tax rate dropped from an average of around 0.9 percent in 1970 to approximately 0.5 percent today. ### Property taxes and recurrent net-wealth taxes - Property taxes: - Are equitable and efficient but underutilized. - Average yield in 65 economies in the 2000s was around 1 percent of GDP. - In developing economies the average yield is only half of that. - Countries outside advanced economies collecting more than 1 percent of GDP through recurrent property taxes include Colombia, Namibia, Russia, South Africa, and Uruguay. - Effective implementation requires sizable investment in administrative infrastructure, particularly in developing economies. - Recurrent taxes on net wealth: - Generally raise little revenue because financial wealth is mobile and taxes are easily evaded. - Few advanced economies have recurrent taxes on broad measures of net wealth; where they exist, revenue is typically low. - More effective exchange of information across economies could mitigate evasion and improve prospects for higher revenue from net wealth taxes. - Distinction: recurrent net wealth taxes differ from one-off levies (capital levies), which carry significant risks of economic distortions and have almost never been successful at raising revenue. ### Inheritance, gift, and transaction taxes - Inheritances and gifts: - Can limit inter-generational inequality and strengthen equality of opportunity. - Where they exist, rates are generally low, exemptions and special arrangements widespread, and revenue yields small. - OECD inheritance revenue declined from 0.35 percent of GDP in 1970 to less than 0.15 percent today. - Examples of higher yields: France at 0.4 percent of GDP and Belgium at 0.65 percent of GDP. - Transaction taxes on property and financial assets: - Administratively appealing because transactions are often observable and easy to administer. - Economically distortive by impeding mutually beneficial trades; real estate transaction taxes can reduce labor mobility and raise unemployment. - Financial transaction taxes (FTT) can have significant social costs: cascading effects (tax levied on tax), increasing costs of capital, encouraging avoidance schemes, and potentially impeding socially worthwhile transactions. - Distributional impact of transaction taxes is unclear because incidence may shift onto consumers. ### Consumption taxes and VAT design recommendations - Consumption taxes are generally inferior for redistribution compared to income-related taxes and transfers. - VAT: - Generally regressive in advanced economies when assessed against current income rather than current consumption. - Often found to be progressive in developing economies. - Excises: - Tend to bear relatively more heavily on people with low incomes in advanced economies, while this is not generally so in developing economies. - Cigarette excise regressivity can be smaller if consumers have time-inconsistent behavior, as excises then correct for lack of self-control. - Design recommendations for indirect taxes: - Minimize the use of exemptions or reduced VAT rates: - Exemptions/reduced rates on necessities are blunt redistributive instruments because the rich often spend more in absolute terms and thus capture benefits. - Advanced economies usually have better instruments (targeted transfers, progressive PIT) to help the poor. - Example: elimination of reduced VAT rates in the United Kingdom, with proceeds used to increase social benefits, significantly reduced inequality while boosting revenue. - In developing countries exemptions and special VAT rates erode the revenue base and reduce opportunities to finance redistributive spending; even poorly targeted public spending is generally better for the poor than reduced VAT rates. - Example: in Ethiopia a uniform VAT with proceeds used for general spending on education and health has a strong progressive impact. - Where capacity constraints prevent spending programs from reaching the poor, some VAT differentiation (e.g., for basic food items) can be justified. - Set a sufficiently high VAT registration threshold: - Small traders face significant compliance burdens; a threshold reduces compliance costs and can strengthen VAT progressivity. - Example: in the Dominican Republic a VAT threshold had a strong pro-poor effect. - Use specific excises mainly for corrective (behavioral/externality) purposes rather than redistribution: - Examples: excises on cigarettes, alcoholic beverages, gambling, and motor fuels. - Carbon taxation can address emissions and local pollution while generating significant revenue; mitigation for low-income groups can be provided via targeted measures. - Special excises on luxury goods (yachts, jewelry, perfumes) generally contribute little to equity objectives, raise little revenue, and add administrative costs (motor vehicle taxes may be an exception). ### Tariffs - Tariffs have unclear implications for inequality. - In developing economies, trade tariffs are a significant public revenue share (about one quarter in sub-Saharan Africa). - Tariff revenue is declining with trade liberalization. - The distributional impact of lowering tariffs depends on whether and how lost revenue is recovered through other domestic revenue sources. ### Summary: fiscal reform menu and principles - Table 1 in the source provides a menu of fiscal policy measures for efficient redistribution in advanced and developing economies, acknowledging that the appropriate mix depends on administrative capacity, redistribution preferences, envisaged state role, and political economy. - Measures could be implemented as part of long-term fiscal reforms or integrated into fiscal consolidation strategies to achieve redistributive goals at lower fiscal cost. - Identified measures include innovative policies not widely implemented, such as increased use of carbon taxes in energy pricing and greater use of property taxation. ### Fiscal consolidation and inequality — evidence and mechanisms - Concerns exist that large fiscal consolidations can increase inequality; public support for redistribution has risen since 2008, especially where the crisis hit hardest. - Mechanisms: - Fiscal consolidation typically leads to short-run reduction in output and employment and often a decline in the wage share, tending to increase market income inequality. - Increasing unemployment tends to widen wage inequality because unskilled wages fall relative to skilled wages. - Duration and magnitude of effects depend on automatic stabilizers and the growth response; high multipliers during downturns can magnify employment effects. - Long-lasting effects can occur if slow growth harms the supply side (e.g., through human capital loss from long-term unemployment). - Composition and pace matter: - Income inequality tends to increase more when adjustment relies on raising regressive taxes and cutting progressive spending. - Econometric studies find spending-cut-based consolidations worsen inequality more than revenue-based ones. - Frontloaded adjustments can have especially strong welfare costs if implemented when unemployment is already high. - Evidence from 27 recent adjustment episodes (advanced economies and emerging Europe): - In about half, market income inequality increased during fiscal consolidations. - In almost two-thirds, fiscal measures led to either a decrease in inequality (decline in disposable income Gini) or at least partly offset worsening market inequality. - Simulations with detailed data show that five countries (Greece, Latvia, Portugal, Romania, and Spain) implemented progressive measures between 2008 and 2012, with richest quantiles bearing most of the adjustment cost. - For some countries (Italy, United Kingdom) impacts were less redistributive and smaller in size; for Lithuania and Estonia the poorest deciles suffered relatively larger income reductions. - Greece: poorest ten percent saw a larger drop in incomes, but overall effect was progressive because second to fourth deciles experienced relatively low decreases. - Results for Ireland (2009–12): aggregate effect of tax and social benefit measures and reductions in the public wage bill decreased incomes of the bottom 10 percent by about 5 percent, and of the top 10 percent by about 13 percent. - Results for Cyprus (2012): tax and payroll contribution increases reduced incomes of households in the bottom 20 percent by 0.1 percent and those of the top 20 percent by 2 percent. - Specific findings on the distributional effects of common consolidation measures: - Public sector wage reductions were progressive because public sector employees were mostly skilled and higher-income; cuts were structured to have greater impact on higher income workers. - Cuts in untargeted benefits were largely progressive; reductions in means-tested benefits were regressive. - Proportional reductions in pensions across all beneficiaries were strongly regressive; where pension freezes/cuts were targeted to high pensions, effects were progressive. - Increases in income tax and social contributions were mostly progressive, though decreases in tax-free thresholds reduced progressivity. - Increases in VAT rates were regressive; degree of regressivity depends on VAT structure and consumption patterns across income groups. *International Monetary Fund — excerpt from "Fiscal Policy and Income Inequality" (section 54–62).* ### 63. This analysis suggests that both expenditure- and revenue-based fiscal adjustments ### _012314 - 63. This analysis suggests that both expenditure- and revenue-based fiscal adjustments ### Design principles and policy recommendations for progressive fiscal adjustment - Both expenditure- and revenue-based fiscal adjustments can be designed to mitigate the adverse effects on inequality. - The appropriate pace of fiscal adjustment depends on: - the state of the economy, - the state of public finances, and - the extent of market pressures. - The progressivity of consolidations depends on the specific design of measures. - Governments could consider the following during fiscal adjustment: - Protect the most progressive and efficient redistributive spending. - Improve targeting to minimize effects on inequality. - Broaden the scope of spending cuts toward: - reducing subsidies, - military spending, and - public sector wages, which can reduce the need for cuts in social transfers. - Rely more on progressive revenue measures to avoid large cuts in social transfers, noting that: - this room may be limited if taxes are already high (Baldacci, Gupta, and Mulas-Granados, 2012). - Consider progressive tax measures, such as: - reductions in regressive tax expenditures, and - greater taxation of wealth and property. - Expand active labor market programs to accelerate the decline in unemployment as growth resumes, including: - job-search support, - targeted wage subsidies, and - training programs. ### Empirical evidence from recent European consolidations (summary of figures and simulations) - Figure 14 and Figure 15 (Avram and others (2013)) simulate impacts of consolidation measures on household disposable income and Gini coefficients for 2008–12: - Bars refer to impact of changes in cash payments, direct taxes, and VAT as a percent of each income quantile’s total household disposable income. - The effect of fiscal consolidation measures equals the difference between Gini coefficients before and after the fiscal consolidation measures (bars). - Coefficients reported reflect simulated effects of consolidation measures adopted during 2008–12 that directly affect disposable income and were not reversed before mid-2012; effects on market income via activity and employment are not captured. - Reported average effects on disposable incomes by country (simulated): - Greece: Average: -11.6 - Portugal: Average: -6.3 - Estonia: Average: -4 - Spain: Average: -4.3 - Italy: Average: -1.6 - Lithuania: Average: -2.8 - Romania: Average: -5.7 - UK: Average: -1.9 - Latvia: Average: -9.1 - Right-axis Gini values (before and after FC measures) shown for countries: Greece, Portugal, Latvia, Spain, UK, Romania, Italy, Lithuania, Estonia (values plotted between 0.27 and 0.35, with effect bars between -0.02 and 0.01 in the figure). ### Developing economies: short-term costs and longer-term outcomes - Short-term effects: - Fiscal consolidations can lead to higher unemployment and potentially increase inequality in the short term. - Longer-term effects: - Over the longer term, adverse effects may be reversed; inequality and unemployment may decline if fiscal adjustment helps: - bring down inflation, or - correct macroeconomic imbalances that hinder growth (Easterly and Fisher, 2001; Agenor, 2002; Albanesi, 2007). - Evidence from past episodes (27 economies) shows: - Fiscal consolidation is associated with increased unemployment in the near term (Figure 16). - By the end of these adjustment episodes, unemployment had declined to close to its pre-adjustment levels and income inequality also declined. - Numerical example from Figure 16 (27 episodes in 16 countries; entire Gini sample includes 68 episodes in 41 countries): - Unemployment rate (percent): Before (3-year average) 12.7; During adjustment 14.0; After (3-year average) 12.9. - Disposable income Gini (right axis): values shown around 0.462, 0.460, 0.456 across periods in the figure. - Interpretation for developing economies: - Much government spending in developing economies is not progressive; therefore spending cuts may not always be damaging to inequality. - To prevent short-term increases in inequality, it will be necessary to strengthen social safety nets to protect vulnerable households during adjustment. - Recommended measures for developing economies include: - Cutting less progressive spending (generalized subsidies, government wages). - Improving targeting of social spending. - Improving incidence of in-kind spending such as education and health. - Including revenue measures for sustainability when needed (Gupta and others, 2005; Bevan, 2010). - Enhancing efficiency and equity of the tax system through greater reliance on progressive taxation. ### Appendix I — Tax incentives for charitable giving (key points) - Advanced countries often provide tax incentives for charitable giving: - Deductible donations: Australia, Belgium, Denmark, Germany, Greece, Japan, the Netherlands, Norway, Switzerland, United Kingdom, United States. - Tax credits at fixed rates: Canada (29 percent), France (6), Ireland (31), Italy (19), New Zealand (33⅓), Portugal (25), Spain (25). - United States: total donations in 2010 were US$291 billion—1.9 percent of GDP—with three quarters from individuals and the rest from firms and foundations. - Distributional issues: - The tax-subsidy generally increases with income because the rich donate more and claim deductions at higher marginal tax rates, rendering the tax subsidy regressive on a per-dollar-donation basis. - The redistributive impact depends on: - whether transfers reduce donors’ ability-to-pay (private consumption), - the types of organizations funded (e.g., higher education and arts versus organizations supporting the basic needs of the poor), and - possible crowding-out of public support (studies often find crowding-out around 20 percent (Schiff, 1985)). - Effectiveness depends on the price elasticity of charitable giving: - If elasticity > 1, the subsidy boosts donations by more than it reduces government revenue. - If elasticity < 1, total support might decline compared to direct government spending. - Literature is contested: most studies find elasticity > 1, though more recent work suggests it might be < 1 (Fack and Landais, 2011). ### Appendix II — Recent fiscal consolidations and income inequality (nine European countries, 2008–12) - Aggregate impacts and composition of consolidation packages varied substantially across countries. - Observed measures across countries included: - Significant public sector pay reductions in Greece, Latvia, Portugal, Romania, and Spain. - Public pension cuts or freezes in Romania, Portugal, and to a lesser extent Spain; pension indexation changes in Estonia. - Large reductions in means-tested benefits in Portugal and the United Kingdom. - Sizeable reductions in untargeted benefits in Lithuania and Latvia. - Income tax hikes played a major role in Greece and Spain; increases in worker social insurance contributions in Latvia and Estonia. - Increases in VAT rates were adopted in all nine countries. - Micro-simulation studies (Callan and others, 2012; Avram and others, 2013; Koutsampelas and Polycarpu, 2013) focusing on disposable income and consumption suggest: - Consolidation packages often relied on progressive measures, but distributional outcomes reflect composition and design. - Country-specific simulation highlights: - Greece: - Overall progressivity driven by progressive public sector pay cuts, pension cuts, and income taxation. - Tax reform reduced tax-free threshold from EUR 12,000 to EUR 5,000 in 2011; the poorest 10 percent hit relatively harder by the reform. - Public sector measures: caps, reduced special allowances, abolition of 13th and 14th salaries for high earners. - Spain: - Progressivity driven by public sector pay cuts and income-tax changes. - Poorest 10 percent relatively harder hit by a cumulative 5 percentage point VAT increase over 2010 and 2012. - Public sector pay cut averaged 5 percent, up to 9.7 percent, followed by a freeze and elimination of 14th month pay. - Italy: - Mildly progressive effect from moderately progressive public sector wage and pension cuts. - Limited household average income loss due to narrow targeting (measures affected a small part of population). - Public sector wages above EUR 90,000 and EUR 150,000 cut by 5 and 10 percent respectively. - Portugal: - Overall progressive incidence due to progressive cuts in public wages and pensions offsetting regressive means-tested transfer cuts. - Public sector pay cuts increased with wage to a maximum of 10 percent; suspension of 13th and 14th months of pay in 2012 (reversed in 2013, after the analysis period). - Benefit reductions included decreases and tighter eligibility for family benefits. - Lithuania: - Moderately regressive path due to slightly progressive public sector pay cuts combined with cuts to untargeted benefits. - Romania: - Overall incidence progressive due to public sector pay cuts, real pension reductions for middle-class and rich pensioners, and means-tested benefits. - Latvia: - Progressivity driven by public sector pay reductions that decreased average wage by about 10.5 percent and cuts in non-pension benefits, offsetting regressive pension cuts. - Estonia: - Overall regressive effect driven by change in indexation of public pensions; means-tested social assistance lessened impact on poorest incomes. - United Kingdom: - Overall incidence progressive, due to higher taxes, especially on the richest 1 percent. - Appendix Figure 1 and Appendix Figure 2 provide country-level decompositions of the aggregate and income-group impacts by measure type (VAT, worker social insurance contributions, income taxes, means-tested benefits, non-means-tested benefits, public pensions, net public wages). *Source: IMF staff analysis in the provided content.* ### References ### References ### Inequality, Redistribution, and Fiscal Policy - Agenor, P.R., 2002, “Business Cycles, Economic Crises, and the Poor,” Journal of Economic Policy Reform, Vol. 5, No. 3, pp. 145–60. - Atkinson, A.B., and F. 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