Opening Remarks of Vitor Gaspar, Director of the Fiscal Affairs Department at a Press Conference Presenting the Fall 2017 Fiscal Monitor: Tackling Inequality

October 11, 2017

This issue of the Fiscal Monitor looks at inequality. First, it documents trends in inequality and examines the role of fiscal policy. Then, it examines the following three policies that are currently widely debated: first, progressive taxation; second, universal basic income (UBI); and third, public spending on education and health.

Before elaborating on the key elements of the Fiscal Monitor, this notes starts with some highlights of the recent fiscal developments.

I. Recent fiscal developments

Economic recovery has gained pace and now encompasses most economies around the world. This creates a global window of opportunity to promote inclusive and sustainable growth by implementing structural reforms, and addressing imbalances and vulnerabilities.

In advanced economies, relative to six months ago, debt dynamics are expected to improve because tighter fiscal stance going forward for the United States, and the improving outlook. However, at almost 110 percent of GDP in 2017, debt is still at record highs. With output gaps closing, policymakers should avoid pro-cyclical fiscal policy, which can be a major factor in ratcheting up debt-to-GDP ratios.

In emerging economies, the pace of fiscal consolidation has slowed to a standstill. The increase in public debt in some countries is particularly concerning, as it coincides with elevated corporate leverage at this stage of the credit cycle.

In low-income and developing countries (LIDCs), fiscal deficits sharply increased between 2011 and 2016. But they are expected to start steadily declining, in 2017. The composition of spending is expected to improve with consolidation relying less on cutting capital spending and more on controlling current spending. One priority is to raise the tax capacity for two reasons. First, mobilizing revenue is essential to finance growth-enhancing expenditures. Investments in public infrastructure, education and health are needed to support inclusive growth and address pressing development needs. In LIDCs, tax capacity is too low—one-half of these countries have a tax ratio below 15 percent of GDP. Second, higher revenues are necessary to service public debt. When interest as a share of tax revenues increases sharply and becomes too high (figure 1), this creates vulnerabilities. Taxes imposed on broad bases provide a stable but elastic source of revenue that goes together with a robust capacity to repay public debt.

II. Tackling Inequality

Inequality trends

If we focus on citizens around the world, global inequality has trended down sharply in recent decades, and that is a change from the upward trend since the beginning of the nineteenth century. Declining global inequality reflects mainly catching up across countries (Figure 2). Differences in per capita income between countries account for about two-thirds of global inequality in 2015.

In contrast, if we look at inequality country by country, we realize that most people around the world live in countries where inequality has increased. It is important to emphasize that inequality has increased in the largest countries in the world: China, India and the United States. More broadly, if we focus on inequality within countries, we observe—as illustrated in figure 3—that over the past three decades inequality has increased in about half of the countries around the world, particularly in advanced economies.

Fiscal redistribution

Fiscal policy is a powerful instrument for achieving redistribution objectives. It accounts for a large share of differences in inequality across countries (figure 4). In advanced economies, fiscal policy offsets about a third of market (before-tax-and-transfer) income inequality, with 75 percent coming from transfers. In-kind transfers such as those for education and health also affect market income inequality over time by changing the distribution of human capital, including across generations by promoting social mobility. In developing economies, fiscal redistribution is much weaker, given lower and less progressive taxes and spending.

Countries wishing to scale-up or redesign redistributive policies need to simultaneously look at taxes and transfers. Redistributive transfers need to be financed and the combination of alternative tax and transfer instruments can have very different implications for equity in the economy. Assessing the impact of policies on efficiency is crucial as well. The reason is that apart from equity, economic welfare is heavily influenced by mean income. While some redistributive policies may have conflicting effects on growth and distribution, empirical evidence shows it is possible to achieve inclusive, sustainable growth.

The level of redistribution and design of redistributive instruments should reflect country-specific circumstances, including underlying fiscal pressures, social preferences, and administrative capacity.

Progressivity of Income Taxes and Transfers

Progressivity of income taxes . At the upper part of the income (and wealth) distribution, taxation is the main tool for redistribution. Tax progressivity has declined over the past three decades (figure 5). This decline is consistent with the drop in top personal income tax rates in OECD countries from an average of 62 percent in 1981 to 35 percent in 2015. Our empirical results suggest that it is possible to increase the degree of tax progressivity while preserving growth, at least for levels of progressivity that are not excessive. In LICDs, as mentioned earlier, developing tax capacity is critical for increasing the distributive role of fiscal policy while ensuring fiscal sustainability.

Universal basic income (UBI). When looking at the spending side, an important choice for countries is the extent to which they rely on universal or means-tested transfers. A UBI is defined in the Fiscal Monitor as a cash transfer of an equal amount to all individuals in a country. The idea is not new. It has been widely debated by economists in the past. It has received growing attention in recent years, partly in response to the perception of the possible effects of artificial intelligence and automation on jobs in the future. The purpose in the Fiscal Monitor is to contribute to the policy debate by presenting the many considerations relevant for evaluating the desirability of a UBI. Because of its universality, a UBI has the potential of having a significant impact on inequality and poverty. But since it is universal, it can be fiscally costly. Therefore, the discussion of a UBI cannot be disentangled from a discussion of its financing. A UBI could be an option as a replacement for inefficient and inequitable social spending (e.g. UBI replacing fuel subsidies). On the other hand, a UBI would not be advisable in a context of low tax capacity or if it were to compete for resources with high priority spending on investment, health and education, for example.

Addressing Inequalities in Education and Health

Investments in education and health help reduce income inequality over the medium term, address persistent poverty across generations, enhance social mobility, and ultimately promote sustainable and inclusive growth. Building human capital is perhaps the best insurance against job insecurity due to rapid technological change.

Despite the relevance of education and health and progress in recent years, gaps of access to quality education and health care services between different income groups in the population remain in many countries, including in advanced economies. For instance, in advanced economies the gap in life expectancy between males with tertiary education and those with secondary education or less ranges from about 4 to 14 years. Better public spending can help, for instance, by reallocating education and health spending from the rich to the poor while keeping total public 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.

To conclude: fiscal policy is a powerful instrument for inclusive and sustainable growth. Fiscal policy can make the difference.

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