Tax and transfer systems play a crucial role in income redistribution and inequality reduction, but concerns have arisen about their effectiveness under the pressure of globalisation and the emergence of new forms of work. This has prompted vivid debates on introducing a universal basic income and reigniting tax progressivity through the taxation of top incomes and wealth (IMF 2017, OECD 2017, WID 2017).
In order to deliver evidence-based policy recommendations in this area, we first need to document and take stock of the extent to which tax and transfer systems mitigate market income inequality today, and how this has changed over a period of rising globalisation, technological change, and pressure from population ageing. This is what we set out to do in a recent paper, by conducting a comprehensive assessment of income redistribution covering OECD countries over the last two decades (Causa and Hermansen 2017).1 Redistribution is quantified as the relative reduction in market income inequality achieved by personal income taxes, employees’ social security contributions, and cash transfers, based on household-level micro data.
New findings
Taxes and transfers reduce market income inequality by slightly more than 25% on average across the OECD (Figure 1); but this average masks a great deal of heterogeneity ranging from 40% in Ireland to around 5% in Chile. The level of redistribution is also highly variable in countries exhibiting similar levels of market income inequality – for example, market income inequality stands at around 38 Gini points in both Japan and Norway, but disposable income inequality stands at around 27 points in Norway compared to 32 points in Japan. Such variations reflect cross-country differences in the size of the public sector, and, indeed, the level of redistribution is strongly associated with the level of public social spending on cash support to the working-age population, as well as to the level of total tax revenues.
Figure 1 The equalising effect of taxes and transfers varies widely across OECD countries, even for similar levels of inequality before taxes and transfers
Note: The Gini index measures the extent to which the distribution of incomes among households deviates from perfect equal distribution. A value of zero represents perfect equality and a value of 100 extreme inequality. Redistribution is measured by the difference between the Gini coefficient before personal income taxes and transfers (market incomes) and the Gini coefficient after taxes and transfers (disposable incomes) in per cent of the Gini coefficient before taxes and transfers. For Hungary, Mexico and Turkey household incomes are only available net of personal income taxes, implying that inequality can only be measured after taxes and before transfers. The three countries are not included in the OECD average. Working-age populations include all individuals aged 18-65. Data refer to 2012 for Japan; 2015 for Chile, Finland, Israel, Korea, the Netherlands, the United Kingdom and the United States; and 2014 for the rest.
Source: OECD Income Distribution Database.
At the same time, size is not enough to explain income redistribution, for instance because it says little about the extent to which social spending accrues to the least affluent households (Figure 2). For example, in Greece, Italy, Portugal, and Spain, 10% or less of total transfers accrues to bottom quintile households, by contrast with more than 40% in Australia, Finland, and New Zealand.
Figure 2 Targeting of cash transfers to low-income households differs across OECD countries
Notes: 1. Armed forces pension and older pension system not included. Data specially provided by Chilean statistical sources. Data refer to 2012 for Japan; 2015 for Chile, Finland, Israel, Korea, the Netherlands, the United Kingdom and the United States; and 2014 for the rest.
Source: OECD Income Distribution Database.
Since the mid-1990s, the redistributive effect of taxes and transfers has declined, both on average and in the majority of OECD countries for which data are available (Figure 3, Panel A). The trend towards less redistribution was most pronounced over the pre-crisis period (1995-2007), and was temporarily reversed during the first period of the crisis (2007-2010), reflecting the cushioning impact of automatic stabilisers and fiscal discretionary measures. Trends in redistribution were more heterogeneous over the most recent decade, with increases in around half of OECD countries, in particular those hardest hit by the crisis (Figure 3, Panel B).
Figure 3 Redistribution has declined for almost all available OECD countries since the mid-1990s
Notes: For Panel A data refer to 1994-2015 for the United Kingdom; 1995-2012 for Japan; 1995-2015 for Finland, Israel, the Netherlands and the United States; 1996-2014 for Czech Republic and France; and 1995-2014 for the rest. For Panel B data refer to 2003-2012 for Japan; 2003-2014 for New Zealand; 2004-2015 for Finland and the United Kingdom; 2005-2014 for Denmark, France and Poland; 2005-2015 for Israel, the Netherlands and the United States; 2006-2015 for Chile and Korea; and 2004-2014 for the rest. See note to Figure 8 for further details on redistribution measure and working-age population.
Source: OECD Income Distribution Database.
By and large, the decline in overall redistribution across OECD countries over the last decades has been primarily driven by a decline in redistribution by cash transfers, which is not surprising insofar as cash transfers account for the bulk of redistribution.2 Personal income taxes also contributed, but played a less important and more heterogeneous role across countries (Figure 4, Panel A). In turn, the decline in transfer redistribution was largely driven by insurance transfers (e.g. unemployment insurance, work-related sickness, and disability benefits). This was partly mitigated by assistance transfers (e.g. minimum income transfers, means- or income-tested social safety net) in some countries such as Germany and the UK (Figure 4, Panel B). Assistance transfers are less redistributive than insurance transfers in many OECD countries, for instance due to low take-up but also due to relatively low benefit amounts, so that their size is generally smaller than insurance transfers. As a result, the decline in transfer redistribution was largely driven by a decline in the size of transfers (i.e. transfer rate averaged across all households).
Figure 4 The redistributive effect of transfers has declined markedly across OECD countries
Notes: 1. Sweden only available for 1995-2005. 2. Social security contributions not available for France. Data refer to 1993-2013 for the Netherlands; 1994-2010 for Canada and France; 1994-2012 for Hungary; 1994-2013 for Germany, the United Kingdom and the United States; 1995-2000 for Belgium; 1995-2005 for Sweden; 1995-2010 for Australia; 1995-2013 for Denmark, Finland and Norway; 1996-2012 for Mexico; 1996-2013 for Czech Republic; 1997-2012 for Israel and Slovenia.
Source: Authors' calculations based on the Luxembourg Income Study.
Declines in the size of personal income taxes and social security contributions (i.e. tax rate averaging across all households) tended to reduce redistribution. However, in some countries like the Czech Republic and the UK, this was compensated by an increase in their progressivity (Figure 5), driven by tax changes at the low end of the earnings distribution. These counteracting changes in size and progressivity of personal income taxes tended to shape redistribution with fairly-equal forces, in contrast to transfers for which changes in size tended to dominate over changes in targeting.
Figure 5 Declines in the size of personal income taxes in most OECD countries tended to reduce redistribution
Notes: 1. Sweden only available for 1995-2005. 2. Social security contributions not available for France.
Source: Authors' calculations based on the Luxembourg Income Study.
The decline in redistribution over the last two decades documented here took place in a period of flattening market income inequalities – indeed, in many OECD countries redistribution has declined by a sufficient margi