Can Policymakers Stem Rising Income Inequality?

IMF Blog, June 28, 2012

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The issue of rising income inequality is central to public debate, with concern over economic and social consequences of increases in the share of income captured by higher income groups.
Much discussion focuses on drivers—globalization, labor market reforms, technological changes favoring higher-skilled workers—but the study emphasizes what policymakers can do.
Public spending and taxation policies have had, and are likely to continue to have, a crucial impact on income inequality in both advanced and developing economies.

Database covers inequality trends in 150 advanced and developing countries.
Disposable income inequality (after taxes and transfers) has increased in most advanced and many developing economies over recent decades.
Inequality is measured by the Gini coefficient (which ranges from 0, when everyone has exactly the same income, to 1 when a single individual receives all the income of a society).
Large variation in average income inequality across regions.
Sharp increase in the share of income captured by the highest income groups since the early 1980s.
- United States example: the share of market (before taxes and transfers) income captured by the richest 10 percent surged from around 30 percent in 1980 to 48 percent by 2008.
Some experts argue that such increases contributed to the recent financial crisis.

Taxes and public transfers have played a significant role in offsetting the increase in inequality.
Over the past two decades, fiscal policy decreased inequality by about one-third in OECD countries.
- Two-thirds of this decrease achieved through transfers such as child benefit and public pensions.
- The redistributive impact is even higher when in-kind transfers such as education and health are included.
The distributive impact of fiscal policy has diminished since the mid-1990s.
- Fiscal policy offset 73 percent of the 3 percentage point increase in market-income inequality up to the mid-1990s.
- Fiscal policy offset 53 percent of the increase up to the mid-2000s.
- Over the whole period, market-income inequality grew by twice as much as redistribution!
Some countries have seen income distribution worsen since 2007 (for example, Ireland and Spain).

Reduction in the generosity of social benefits, particularly unemployment and social assistance benefits.
Lower income tax rates, especially at higher income levels.
These developments are worrisome given the need for substantial fiscal consolidation in advanced economies in the coming years.

Allow automatic stabilizers (such as unemployment benefits) to work during consolidation.
Protect the most progressive social benefits.
Remove opportunities for tax avoidance and evasion.
Increase reliance on wealth and property taxes.

Inequality in developing countries is substantially higher than in advanced economies.
Much of the higher inequality can be explained by lower levels of taxation and public spending, as well as greater reliance on less progressive tax and spending instruments.
Policy levers:
- Tax side: focus on broadening tax bases rather than increasing tax rates, through reduced tax exemptions, closing loopholes and improving compliance.
- Spending side: improve the progressivity of public spending by eliminating general price subsidies and better targeting of poverty programs to the most vulnerable.
Continued tight revenue constraints and large demands to finance development objectives imply greater emphasis on spending progressivity.

Source: Can Policymakers Stem Rising Income Inequality? — David Coady, Sanjeev Gupta, June 28, 2012

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