Fiscal Policy and Income Inequality

Francesca Bastagli – Overseas Development Institute

Taxation & Developing Countries (a PEAKS training course)

16 September 2013

Overview

• Trends in income inequality

• The impact of direct taxes and transfers

• Revenue and spending comparisons: Levels and composition

• Policy implications

• What are the key policy challenges in low-income countries?

2

Inequality Trends

Trends

• Income inequality is increasing in many countries.

Does this matter?

• Intrinsic value

If existing income inequality is perceived as the outcome of unfair processes and unequal access to opportunities.

• Instrumental value

Can help to reduce inequality in other dimensions that matter (social, political, economic), promote progress in poverty reduction and growth.

3

Inequality Trends

Source: Bastagli, Coady and Gupta (2012)

4

Inequality Trends

• High-income countries: in most countries inequality started increasing in the 1980s and through the mid-1990s.

• Eastern Europe: between the late 1980s and mid-1990s inequality increased in most transition countries and has followed mixed trends since then.

• Latin America and the Caribbean: region with the highest income inequality; most countries experienced an increase in income inequality during the 1980s and until the 2000s; from then inequality has declined in most countries. Levels in 2006 close to those of the early 1990s; more recently continued decline.

• Sub-Saharan Africa: mixed trends in expenditure inequality; decreased in 4 out of 6 countries for which data are available in 1980s-1990s; little change in countries for which data are available in the late 1990s.

• Asia and the Pacific: from the mid-1990s to 2007, inequality increased in 14 countries and decreased in 8 countries.

• Middle East and North Africa: inequality increased in 9 of 12 countries in the region between 1990 and 2005.

5

Inequality Trends

• Also striking, the difference in inequality between higher-income and developing countries:

Average inequality in the two most unequal regions (Latin America and Sub-Saharan Africa) exceeded a Gini of 0.45 every year. In the two most equal regions (Eastern Europe and High-income OECD countries) was less than 0.34. A difference of 11 percentage points.

Income inequality in Norway: 0.25 and Sweden: 0.26, in Brazil: 0.54 and South Africa: 0.65 (late 2000s).

6

Impact of Direct Taxes and Transfers

• Income inequality was reduced by one-third in OECD countries (Source: OECD, 2011)

7

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Gross income Disposable income

Impact of Direct Taxes and Transfers

• Income inequality was reduced by 2 percentage points on average in LAC countries (Source: Elaboration from Lustig et al, 2012)

8

0.573 0.549

0.504 0.503 0.542 0.532

0.494 0.465

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Market income Disposable income

Impact of Direct Taxes and Transfers

• Non-MT transfers, MT benefits, personal taxes and social insurance contributions (Source: Paulus et al, 2009)

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Limited Scope For Generalisations, However…

• The redistributive effect is on average larger for non-means-tested benefits, followed by personal taxes and M-T benefits.

• In-kind transfers (e.g., education and health) also reduce inequality (nearly 5pp on average).

• Equalising impact of personal income taxes, which fall more heavily on higher income groups.

• Indirect taxes tend to be regressive; e.g. consumption taxes have a significant regressive impact in OECD countries.

10

Impact of Policy in Developing Countries is

Limited… by Low Revenue

Source: Bastagli, Coady and Gupta (2012)

11

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15

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Advanced Emerging Europe

Latin America

Middle East and North

Africa

Asia and Pacif ic

Sub-Saharan Africa

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t o

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DP

Tax,2010 or latest

Indirect Income Corporate Property

Impact of Policy in Developing Countries is

Limited… by Low Spending

Source: Bastagli, Coady and Gupta (2012)

12

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5

10

15

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Advanced Emerging Europe

Latin America

Middle East and North

Africa

Asia and Pacif ic

Sub-Saharan Africa

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Social Spending,2010 or latest

Transfers Health Education

Also Limited By the Composition of Policy

• Heavy reliance on indirect taxes (in many cases regressive since exempt items are not those disproportionately purchased by the poor).

• Narrow income tax base (high “informality”, non-compliance, preferential treatment of capital and other incomes).

• Social insurance benefits restricted to formal sector (tend to be regressive).

• Social assistance spending often low and/or poorly targeted (e.g. universal price subsidies).

13

In Kind Transfers are Also Often Regressive

Source: Bastagli, Coady and Gupta (2012)

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Education

In Kind Transfers are Also Often Regressive

Source: Bastagli, Coady and Gupta (2012)

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Health

Policy Implications: Enhancing the

Redistributive Role of Policy

• Strengthening resource mobilization capacity

– Expansion of progressive tax policy instruments – Expansion of corporate and personal income tax

bases through reducing exemptions, closing loopholes, and improving tax compliance

– Employment formalization and social insurance expansion

– Improvement in administrative capacity

• Higher spending with elements of targeting

– Expansion and improved targeting of social assistance (eliminate universal price subsidies)

– Expansion of health and education

16

Policy Implications and Follow-up Issues

• Inequality is increasing in most countries and taxes and transfers are an important set of instruments governments can use to address it.

• Taxes and transfers should be considered jointly.

• General conclusions with respect to particular taxes are quite hard to find – progressivity/regressivity conclusions are country-specific and design details matter.

17

Overseas Development Institute

203 Blackfriars Road, London, SE1 8NJ

T: +44 207 9220 300

www.odi.org.uk

f.bastagli@odi.org.uk