Credit: Wealth and poverty side-by-side in Rio de Janeiro, Brazil: inequality is rising within countries around the world

Inequality: Fiscal Policy Can Make the Difference

Vitor Gaspar, Mercedes Garcia-Escribano

October 11, 2017

 October 11, 2017

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[caption id="attachment_21650" align="alignnone" width="1024"] Wealth and poverty side-by-side in Rio de Janeiro, Brazil: inequality is rising within countries around the world (photo: Jean-Marc David/SIPA/Newscom). [/caption]

Income inequality among people around the world has been declining in recent decades. This is due to countries like China and India’s incomes catching-up to advanced economies. But the news is not all good. Inequality within countries has increased, particularly in advanced economies. Since the global economic recovery has gained pace and is now widespread, policymakers have a window of opportunity to respond with reforms that tackle inequality, and our new Fiscal Monitor shows how the right mix of fiscal policies can make the difference.

Fiscal policy is powerful

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 also 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.

Design of redistribution matters

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. Also, taxes and transfers cannot be considered in isolation. Countries need to finance transfers, and the combination of alternative tax and transfer instruments that countries chose can have very different implications for equity.

While some policies may have conflicting effects on growth and distribution, our 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.

Tackling inequality

Policymakers have many choices to achieve efficient and equitable results. The Fiscal Monitor focuses on three policy debates: progressive taxation, universal basic income (UBI), and public spending on education and health.

We hope to have persuaded you of two things: that fiscal policy can make the difference in tackling inequality; and that efficiency and equity must go hand-in-hand.

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