Inequality: Fiscal Policy Can Make the Difference

IMF Blog, October 11, 2017

Source details

Income inequality among people around the world has been declining in recent decades due to countries like China and India’s incomes catching-up to advanced economies.
Inequality within countries has increased, particularly in advanced economies.
With the global economic recovery gaining pace and now widespread, policymakers have a window of opportunity to respond with reforms that tackle inequality.
The Fiscal Monitor shows how the right mix of fiscal policies can make the difference.

Fiscal policy accounts for a large share of differences in inequality across countries.
In advanced economies, fiscal policy offsets about a third of income inequality before taxes and transfers—commonly known as market income inequality—with 75 percent coming from transfers.
Spending on education and health affects market income inequality over time by promoting social mobility, including across generations.
In developing economies, fiscal redistribution is much weaker, given lower and less progressive taxes and spending.

There is no one-size-fits-all strategy; redistribution should reflect a country’s specific circumstances, including underlying fiscal pressures, social preferences, and the government’s administrative and tax capacity.
Taxes and transfers cannot be considered in isolation because transfers must be financed; different combinations of tax and transfer instruments can have very different implications for equity.
Some policies may have conflicting effects on growth and distribution, but empirical evidence shows it is possible to achieve inclusive, sustainable growth with the right mix of policies.
Efficiency and equity can and must go hand-in-hand.

The Fiscal Monitor focuses on three policy debates: progressive taxation, universal basic income (UBI), and public spending on education and health.

Progressive income taxes

Personal income tax progressivity declined steeply in the 1980s and 1990s, and has remained broadly stable since then.
The average top income tax rate for OECD member countries fell from 62 percent in 1981 to 35 percent in 2015.
Tax systems are less progressive than statutory rates indicate because wealthy individuals have more access to tax relief.
Some advanced economies can increase progressivity without hampering growth, as long as progressivity is not excessive.

Universal basic income (UBI)

A UBI is defined as a cash transfer of an equal amount to all individuals in a country.
The Fiscal Monitor does not advocate for or against UBI but presents facts and arguments relevant to its evaluation.
A UBI can have a significant impact on inequality and poverty because it covers all individuals at the bottom of the income distribution.
Universality makes a UBI costly: the Fiscal Monitor estimates that it would cost the average advanced economy 6½ percent of GDP to provide a UBI set at 25 percent of median per capita income, and the estimates vary considerably across countries.
Discussion of a UBI cannot be disentangled from discussion of its financing to make it budget neutral.
Key considerations for UBI introduction include consistency with other fiscal priorities—to avoid crowding out investments in infrastructure, education and health—and the method of financing, which needs to be efficient and equitable.
A UBI could be an option where it substitutes for inequitable and inefficient social spending.

Spending on education and health

Gaps in access to quality education and health care services between different income groups remain in many countries despite progress.
In advanced economies, males with tertiary education live up to 14 years longer than those with secondary education or less.
Better public spending can help by reallocating education or health spending from the rich to the poor while keeping total public education or health spending unchanged.
The Fiscal Monitor finds that closing the inequality gap in basic health coverage could raise life expectancy, on average, by 1.3 years in emerging and developing countries.

Vitor Gaspar, Mercedes García-Escribano — October 11, 2017