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Disentangling income inequality and the redistributive effect of social transfers and taxes in 36 LIS countries

Wang, Chen and Caminada, Koen (2011): Disentangling income inequality and the redistributive effect of social transfers and taxes in 36 LIS countries. Published in: Department of Economics Research Memorandum No. 2011.02 (4. August 2011): pp. 1-53.

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Abstract

The aim of this paper is to offer detailed information of fiscal redistribution in 36 countries, employing data that have been computed from the Luxembourg Income Study’s micro-level database. LIS data are detailed enough to allow us to measure both overall redistribution, and the partial effects of redistribution by several taxes or transfers. We elaborate on the work of Jesuit and Mahler (2004) and Mahler and Jesuit (2006), and we refine, update and extent their Fiscal Redistribution approach. LIS data allow us to decompose the trajectory of the Gini coefficient from primary to disposable income inequality in several parts: we will distinguish 11 different benefits and several income taxes and social contributions in our empirical investigation across countries. First, we use LIS data to analyze income inequality and the redistributive effect of social transfers across countries in a descriptive way. Then we proceed with a simulation approach for 36 countries for which we decompose income inequality through several taxes and transfers. We analyze the redistributive effect of several social programs, like unemployment benefits or pensions and income taxes. We develop a budget incidence simulation model to investigate to what extent several social transfers contribute to the overall redistribution in modern welfare states under a strong assumption that the absence of social transfers and taxes would not change individual behavior and labor supply. Among all countries listed in this paper, Denmark and Sweden have the smallest income disparity, while Peru and Colombia have the largest. Nordic countries show the most equally distributed disposable incomes and primary incomes, comparing to the countries in other types of welfare states. On average, large primary income disparity exists in Anglo-Saxon countries. Generally speaking, European countries achieve lower levels of income inequality than other countries. With respect to the redistributive effect, our budget incidence analysis indicates that the pattern is diverse across countries. The largest redistribution is found for Belgium, while Colombia and Peru show rather limited overall redistributive effects. On average, transfers reduce income inequality by over 85 percent, while taxes account for only 15 percent of total redistribution. Among all welfare states, Continental European countries (Belgium, France, Germany, and Luxembourg) achieve the highest level of the reduction of initial income inequality. As far as social programs is concerned, in most countries two dominant income components account for above 50 percent of total reduction in income inequality: the public old age pensions and the survivors scheme, and the income taxes. For example, in Southern European Countries the public old age benefits account for over 80 percent of total redistribution, while these figures are much lower for Anglo-Saxon Countries (20-34%), for Nordic Countries (31-48%), for Continental European Countries (47-57%), and for Central Eastern European Countries (54-70%). In Anglo-Saxon Countries income taxes play a major role (above 30%) compare to other countries (with the exception the United kingdom). Also the redistributive effect of social assistance and child and family benefits in the Anglo-Saxon Countries are relatively high in a comparative setting (9-28%). In Nordic Countries also a variety of other social programs contribute to the reduction of inequality, especially the disability scheme (9-15%). Remarkably, across countries all other social benefit programs seem to have rather limited redistributive effects, although the unemployment compensation benefits do have some effect too.

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