Income Inequality and Fiscal Policy in Low-Income Countries Sanjeev - PowerPoint PPT Presentation

Low-Income Countries Seminar Income Inequality and Fiscal Policy in Low-Income Countries Sanjeev Gupta Fiscal Affairs Department International Monetary Fund March 15, 2013

Presentation is based on: F. Bastagli, D. Coady, and S. Gupta, 2012, “Income Inequality and Fiscal Policy”, IMF Staff Discussion Note, SDN/12/08(Revised). Available at: http://www.imf.org/external/pubs/cat/longres.aspx?sk= 40024 2

Background � Income inequality has increased in most advanced and many developing economies over recent decades � Emphasis on inclusive growth has led to a growing concern about income inequality in developing countries (e.g., China and India) � So how can fiscal policy contribute to lowering income inequality? 3

Plan of Presentation I. Role of fiscal policy II. Trends in income inequality III. How has fiscal policy affected income inequality in advanced economies? IV. How effective has fiscal policy been at reducing inequality in developing countries? V. Lessons for the design of fiscal policy in developing countries 4

I. Role of Fiscal Policy 5

I. Role of Fiscal Policy � Fiscal policy can affect income distribution � Directly . By reducing inequality of disposable incomes compared to inequality of market incomes � Indirectly. Through impact on future earnings of individuals and inequality of market incomes � Role likely to vary across countries reflecting range of policy instruments available but also social preferences towards equity and efficiency � But taxes and transfers may distort allocation of resources (equity-efficiency trade-off) 6

II. Trends in income inequality 7

Income inequality is substantially higher in low- income economies….. Trends in Disposable Income Inequality, 1980–2010 0.55 0.50 0.45 Gini coefficient 0.40 0.35 0.30 0.25 0.20 1980 1985 1990 1995 2000 2005 2010 Latin America and Caribbean Sub-Saharan Africa Middle East and North Africa Asia and Pacific Emerging Europe Advanced 8

…..and has been increasing in many of these 10 12 14 16 18 0 2 4 6 8 Nepal China Sri Lanka Changes in Disposable Income Inequality Across Regions, 1990–2005 Indonesia Asia and Lao PDR Pacific Bangladesh Cambodia India Vietnam Mongolia (Percentage-point change in Gini coefficient) Philippines Paraguay Honduras Colombia Venezuela, RB Bolivia America Latin Uruguay Costa Rica Argentina Dominican Republic Jamaica Guatemala Turkmenistan Kyrgyz Republic Uzbekistan Tajikistan Middle East and North Djibouti Africa Morocco Tunisia Mauritania Egypt, Arab Rep. Rwanda South Africa Niger Ghana Sub-Saharan Côte d'Ivoire Africa Tanzania Mozambique Zambia Madagascar 9 Burundi

More recently, the focus has been on the rising income share of the top income groups Gross Income Share of Top One-Percent in Selected Advanced and Developing Economies, 1925–2010 25 25 United States United Kingdom France Germany Australia Canada Japan Netherlands South Africa India Sweden 20 20 15 15 Percent Percent 10 10 5 5 0 0 Source: World Top Incomes Database 10

III. How has fiscal policy affected income inequality in advanced economies? 11

In advanced economies, fiscal policy has reduced income inequality by one-third …. Redistributive impact in OECD countries, 2008 � Gross income average = 0.45 � Disposable income average = 0.30 0.6 0.6 0.6 0.6 0.5 0.5 0.5 0.5 0.4 0.4 0.4 0.4 0.3 0.3 0.3 0.3 0.2 0.2 0.2 0.2 0.1 0.1 0.1 0.1 0 0 0 0 12 Source: OECD, 2008. Gross income Disposable income Disposable income Gross income Gross income

…..with about two-thirds of this impact is achieved on the expenditure side Redistributive impact of tax and spending 0.30 0.25 Change in Gini coefficient 0.20 Transfers and taxes = 0.15 0.15 Transfers = 0.10 0.10 0.05 0.00 non means-tested means-tested personal social insurance benefits benefits taxes contributions Source: Paulus, 2009. 13

Indirect taxes and in-kind transfers also influence the redistributive impact of fiscal policy � Indirect taxes . Studies find that the value-added tax (VAT) and excise duties are regressive in European countries (O’Donoghue et al., 2004; Warren, 2008) � In-kind transfers. Spending on education, health care and housing benefits decreased the Gini coefficient by 5.8 percentage points on average in 5 European economies (Paulus et al., 2009) 14

Corporate income taxes may not be as progressive as often assumed � The incidence of corporate taxes will tend to fall on wages as capital is more mobile � However, taxation of “rents” (above normal profits) is likely to fall on owners of capital 15

However, the redistributive impact of fiscal policy has decreased since the mid-1990s Diminishing Redistributive Impact of Fiscal Policy Since Mid-1990s 80 45 73.2 39.8 39.2 40 70 36.2 35 60 52.5 28.3 30 27.4 26.7 50 Gini coefficient Percent 25 40 20 30 15 20 10 10 5 0 0 Market Income Disposable Income Fiscal Redistribution (left) (left) (right) mid-1980s mid-1990s mid-2000s Source: Immervoll and Richardson, 2011; OECD, 2011. 16

IV. How effective has fiscal policy been at reducing inequality in developing countries? 17

Impact of fiscal policy in developing economies is limited by low tax-spending levels… Levels and Composition of Tax Revenues and Social Spending 40 30 Property Education Tax, Social Spending, Corporate Health 2010 or latest 2010 or latest 35 Income 25 Transfers Indirect 30 Percent of GDP Percent of GDP 20 25 20 15 15 10 10 5 5 0 0 Advanced Emerging Latin Middle Asia and Sub- Advanced Emerging Middle Latin Sub- Asia and Europe America East and Pacific Saharan Europe East and America Saharan Pacific North Africa North Africa Africa Africa 18

…..as well as less progressive taxes and transfer programs � Greater reliance on indirect taxes and narrower tax bases � Progressivity of direct taxation is weakened by tax noncompliance and narrow tax bases � On the spending side, poor targeting limits the redistributive capacity of transfer programs 19

Energy price subsides as a percentage of GDP 14 13.2 Post-tax 12 4.6 Tax- subsidies 10 Percent of GDP 8 Pre-tax 6 4.7 4.1 8.6 4 3.4 3.0 1.8 3.3 1.8 1.6 2 1.1 1.7 1.6 1.6 0.9 0.6 0 0.0 MENA CEE-CIS Sub-Saharan Africa E.D. Asia LAC Advanced 20

Fuel subsidies benefit upper income groups the …across all products most… Gasoline Diesel Second Bottom quintile, 5.7 Bottom quintile, 3.0 quintile, 7.3 Third Second quintile, quintile, 11.7 9.7 Bottom quintile, 7.2 Top quintile, Fourth 42.0 Third Top quintile, quintile, 19.4 quintile, 16.3 61.3 Second quintile, 11.4 Fourth quintile, 22.6 Top quintile, 42.8 Third quintile, 16.2 Kerosene Bottom LPG Second quintile, 3.8 quintile, 7.6 Bottom Top quintile, quintile, 19.0 Third 20.6 quintile, 12.6 Second Fourth quintile, 22.5 Fourth quintile, 19.7 Top quintile, quintile, 20.1 Fourth 53.8 quintile, 20.8 Third 21 quintile, 20.6

Fiscal policy accounts for nearly 3/4 of Europe vs. Latin America Gini difference Re-distributional impact: Europe vs. Latin America 0.25 0.6 0.23 0.52 0.5 0.5 0.2 0.46 0.17 0.4 0.15 0.3 0.27 0.1 0.2 0.05 0.1 0 0 Latin America Europe Right-side axis Gross income Disposable income Disposable gini difference Fiscal impact Source: Goñi, López and Servén, 2008 22

regressive in many developing economies In-kind public spending has been found to be 10 20 30 40 50 60 70 0 Chile (1996) Romania (1997) Argentina (1993) Education Benefit Incidence for Bottom 40% Dominican Republic… Bulgaria (1997) Malawi (1997) Macedonia (1996) Benefit Incidence of Education and Health Public Spending Mexico (1996) Peru (1994) Mongolia (1995) Kyrgyz Republic (1993) Cote d' Ivoire (1995) Guyana (1993) Panama (1997) Tanzania (1993) South Africa (1993) Mozambique (1996) (share of bottom 40 percent) Bangladesh (2000) Ecuador (1998) Vietnam (1993) Armenia (1996) Kazakhstan (1996) Madagascar (1993) Nepal (1996) Nicaragua (1993) Guinea (1994) 10 20 30 40 50 60 70 80 0 Argentina (1993) Chile (1992) Colombia (1992) Health Benefit Incidence for Bottom 40% Costa Rica (1992) Jamaica (1993) Honduras (1995) Brazil (1990) Peru (1997) Mongolia (1995) Tanzania (1993) Bangladesh (2000) South Africa (1993) Egypt (1994) Kenya (1992) Madagascar (1993) Mozambique (1996) Bulgaria (1995) Vietnam (1993) Indonesia (1990) Romania (1997) Ghana (1998) India (1996) Ecuador (1998) Guinea (1994) 23

Conditional cash transfers � The recent expansion of “conditional cash transfer” programs provides a promising approach for enhancing the distributive power of public spending in developing economies � The largest programs, in Brazil and Mexico, have reduced the Gini by 2.7 percentage points (Soares et al., 2007) � However, these programs need to be targeted to the poorest households 24

V. Lessons for the design of fiscal policy in developing countries 25