Fiscal Policy and Inequality: What Do We Know? Benedict Clements International Monetary Fund

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Fiscal Policy and Inequality: What Do We Know? Benedict Clements International Monetary Fund

Outline of the presentation q Trends in Inequality and the Redistributive Role of Fiscal Policy q Lessons from the Literature on Policy Design q q q Tax Policies Expenditure Policies Fiscal Consolidation and Income Distribution q Key Areas for Additional Research 2

Trends in Inequality and the Redistributive Role of Fiscal Policy 3

While world income inequality has been going down Evolution of World Inequality, 1820-2010 80 Percent (Gini) 75 70 65 60 55 50 Historical series Gini coefficient Recent period 1990 1990 1995 2005 2000 2010 1995 2000 160 140 120 100 80 Gap 45 40 Mean income gap between top and bottom 10% 2005 2010 60 35 40 30 20 Sources: Bourguignon, The Globalization of Inequality. The indexes of PPP that Angus Maddison used for the historical data referenced the year 1990. The data for the recent period use PPP data based on price statistics that were collected in 2005, which sometimes resulted in significant revisions to the parity indexes. This explains much of the discontinuity between the two series in 1990. 4

within countries inequality has been increasing in most advanced economies and in large emerging ones Income Inequality in the 1980s and 2000s Advanced Economies Developing Economies 5

Trends in inequality vary by region 0.55 0.5 0.45 Gini coefficient 0.4 0.35 0.3 0.25 0.2 1980 1985 1990 1995 2000 2005 2010 Latin America and Caribbean (19) Advanced (21) Asia and Pacific (14) Emerging Europe (21) Middle East and North Africa (12) Sub- Saharan Africa (22) 6

More recently, the focus has been on the rising income share of top income earners Gross Income Share of Top One-Percent in Selected Advanced and Developing Economies, 1925 2012 25 25 20 20 Percent 15 10 15 10 5 5 0 0 United King dom Australia Canada South Africa India United States France Germany Japan Netherlands Sweden 7

Since the crises, public support for redistribution has increased, especially in advanced economies where the crisis hit harder Public Support for Redistribution (Percent) Sources: Clements, Gaspar, Gupta and Kinda (2015); Authors estimates based on Integrated Values Survey data. 8

Wealth inequality is significantly more pronounced than income inequality Inequality of Wealth and Income Sources: Davies and others (2008); Luxembourg Income Study; Organisation for Economic Co-operation and Development; Socio-Economic Database for Latin America and the Caribbean (CEDLAC and the World Bank). Note: Data labels in the figure use International Organization for Standardization (ISO) country codes. 9

Inequality of income and inequality of opportunities tend to be related 0.5 GBR ITA Generational earnings elasticity (less mobility ) 0.4 0.3 0.2 FIN SWE NOR DNK GER NZL FRA AUS CAN USA CHE ESP JPN y = 0.0251x - 0.3709 0.1 20 25 30 35 Gini (around 1985; higher inequality ) 10

Fiscal redistribution reduces inequality by one third in advanced economies, mostly through spending 0.30 0.25 From taxes From transfers Average market income Gini: 0.43 Average disposable income Gini: 0.29 Absolute Gini reduction 0.20 0.15 0.10 Total redistribution: 0.14 0.05 0.00 DNK CZE BEL SVN NOR GBR FIN AUT SWE LUX DEU FRA AUS IRL NLD ISR CAN USA EST ITA GRC ESP KOR TWN From transfers: 0.09 11

The contribution of fiscal policy to reduce inequality is smaller in developing countries Level and Composition of Tax Revenues and Social Spending, 2010 45 40 35 Education Health Social protection Tax revenues Total revenues 30 Percent of GDP 25 20 15 10 5 0 Advanced {30; 29} Emerging Europe {14; 16} Latin America and the Caribbean {23; 21} Middle East and North Africa {19; 18} Asia and Pacific {23; 19} Sub-Saharan Africa {34; 35} Source: IMF database. Note: Numbers in brackets refer to number of countries in the {tax; spending} country samples. 12

Lessons for Policy Design 13

Designing efficient redistributive fiscal policy q Redistributive fiscal policy should be consistent with macroeconomic objectives q Policies need to be carefully designed taking into account also indirect and medium-long term effects q Design should take into account administrative capacity q The impact of tax and spending policies should be evaluated jointly 14

Efficient design requires looking at tax and spending together India Simulated Net Impact by Decile of Combined Tax and Transfer Reforms Source: IMF staff estimates based on the 2011/12 Indian National Sample Survey and the Employment Unemployment Survey 15

Tax policy: reform options to achieve more efficient redistribution of taxation Direct taxes Advanced Developing Implement progressive personal income tax (PIT) rate structures Relieve low-wage earners from tax or social contributions Expand coverage of PIT More effectively tax multinational corporations Utilize better opportunities for recurrent property taxation 16

Tax policy: reform options to achieve more efficient redistribution of taxation Indirect taxes Advanced Developing Minimize VAT exemptions and special VAT rates Use specific excises mainly for purposes other than redistribution 17

Expenditure policy: reform options to achieve more efficient redistribution of spending Education Advanced Developing Improve access to education of low-income families Health Expand coverage of publicly financed basic health package Advanced Developing Ensure or maintain access of low-income groups to essential health services 18

Expenditure policy: reform options to achieve more efficient redistribution of spending Social transfers Intensify the use of active labor market programs and in-work benefits Expand conditional cash transfer (CCT) programs as administrative capacity improves Advanced Developing Increase effective pension retirement age while protecting low-income pensioners Expand noncontributory means-tested social pensions 19

Other lessons Heterogeneity among countries must be taken into account when designing fiscal policies: q income levels and pre-tax & transfers levels of inequality differ significantly among countries q administrative capacity may constrain policy options (for instance for ensuring tax compliance or effective targeting) q institutional design varies among countries and may have an effect on distributional outcomes (for instance decentralization/centralization of certain functions) 20

Fiscal consolidation and redistribution Unemployment Rates and Gini Coefficients During Fiscal Adjustment (percent) Sources: Solt (2014); Eurostat; and IMF, World Economic Outlook. Note: Fiscal adjustment episodes are defined as in Escolano and others 2014 based on changes in cyclically adjusted primary balances in countries with positive primary gaps. The sample covers 91 episodes across 49 advanced and developing economies between 1945 and 2012. 21

Fiscal consolidation and redistribution: Impact of austerity on inequality 1.4 1.2 1 0.8 0.6 0.4 0.2 0 0 1 2 3 4 5 6 7 8 estimate lower limit upper limit Note: dotted lines equal one standard error bands. 22

Fiscal consolidation and redistribution: Impact of austerity on labor share of income 0 0 1 2 3 4-0.5-1 - 1.5 estimate lower limit upper limit Note: dotted lines one standard error bands. 23

Fiscal consolidation and redistribution Changes in Market- and Disposable-Income Gini Coefficients, 2007-13 Source: EUROMOD statistics on Distribution and Decomposition of Disposable Income, accessed at http://www.iser.essex.ac.uk/euromod/ statistics/ using EUROMOD version No. G2.0. Note: An increase in the Gini coefficient indicates an increase in inequality. The Gini coefficient for market income is estimated based on disposableincome micro data by adding back (in the case of taxes) or deducting (in the case of benefits) each income component, using the EUROMOD microsimulation model. Estimates for market-income Gini in 2007 and 2013 are based on European Union Statistics on Income and Living Conditions 2008 (income reference period: 2007) and European Union Statistics on Income and Living Conditions 2010 (income reference period: 2009), respectively. For the latter, market-income updates from the income reference period to later years are based on a combination of updating factors. For more information on the exact updating factors used for each country, please refer to the Country Reports (https://www.iser.essex. ac.uk/euromod/resources-for-euromod-users/country-reports). Changes between years and tax-benefit components are not necessarily statistically significant. Data labels in the figure use International Organization for Standardization (ISO) country codes. 24

Fiscal consolidation and redistribution Redistributive Effect of Fiscal Policy, 2007-13 (Effect on Gini Coefficient) Source: Clements, Gaspar, Gupta, and Kinda (2015). EUROMOD statistics on Distribution and Decomposition of Disposable Income, accessed at https://www.iser.essex.ac.uk/files/euromod/ Statistics/WebStatistics_July1_2014_Gini_Datasets_Population_Exchangerates.xlsx using EUROMOD version No. G2.0. Note: A negative number indicates a decline in income inequality (the Gini coefficient) due to fiscal policy. The figure measures the change in disposable income (which reflects government tax and transfer programs) minus the change in market incomes. 25

Key Areas for Additional Research 26

Fiscal policy and inequality key research issues in advanced economies Interaction of labor market institutions and social benefits q More generous social benefits or minimum wages reduce employment; is raising employment more important? q How to foster equality of opportunity especially for those from single parent households/disadvantaged households Incidence of public spending over lifetimes (do pension systems redistribute lifetime income?) Better evidence on tax incidence, taking into account the shifting of tax burdens (who bears the burden of corporate taxation?) 27

Fiscal policy and inequality key research issues in developing economies How to protect the poor during fiscal consolidation when the poor are in the informal sector How to expand benefits to low-income groups without creating incentives to stay in the informal sector Improving human capital of the poor (education and health attainment) are key to reducing inequality; how can this be done when so much public spending is inefficient? 28