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

Income Inequality and Fiscal Policy in Low-Income Countries

Sanjeev Gupta Fiscal Affairs Department International Monetary Fund March 15, 2013

Low-Income Countries Seminar

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

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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?

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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

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• I. Role of Fiscal Policy

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• 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)

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• II. Trends in income inequality

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Trends in Disposable Income Inequality, 1980–2010

Income inequality is substantially higher in low- income economies…..

0.20 0.25 0.30 0.35 0.40 0.45 0.50 0.55 1980 1985 1990 1995 2000 2005 2010 Gini coefficient Latin America and Caribbean Sub-Saharan Africa Middle East and North Africa Asia and Pacific Emerging Europe Advanced

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2 4 6 8 10 12 14 16 18 Nepal China Sri Lanka Indonesia Lao PDR Bangladesh Cambodia India Vietnam Mongolia Philippines Paraguay Honduras Colombia Venezuela, RB Bolivia Uruguay Costa Rica Argentina Dominican Republic Jamaica Guatemala Turkmenistan Kyrgyz Republic Uzbekistan Tajikistan Djibouti Morocco Tunisia Mauritania Egypt, Arab Rep. Rwanda South Africa Niger Ghana Côte d'Ivoire Tanzania Mozambique Zambia Madagascar Burundi

Changes in Disposable Income Inequality Across Regions, 1990–2005 (Percentage-point change in Gini coefficient)

…..and has been increasing in many of these

Latin America Middle East and North Africa Sub-Saharan Africa Asia and Pacific

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5 10 15 20 25 Percent United States United Kingdom Australia Canada South Africa India 5 10 15 20 25 Percent France Germany Japan Netherlands Sweden

Gross Income Share of Top One-Percent in Selected Advanced and Developing Economies, 1925–2010

More recently, the focus has been on the rising income share of the top income groups

Source: World Top Incomes Database

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• III. How has fiscal policy

affected income inequality in advanced economies?

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0.1 0.2 0.3 0.4 0.5 0.6 0.1 0.2 0.3 0.4 0.5 0.6 Disposable income Gross income

In advanced economies, fiscal policy has reduced income inequality by one-third ….

Source: OECD, 2008.

Redistributive impact in OECD countries, 2008

0.1 0.2 0.3 0.4 0.5 0.6 0.1 0.2 0.3 0.4 0.5 0.6 Gross income Disposable income Gross income

• Gross income average = 0.45
• Disposable income average = 0.30

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…..with about two-thirds of this impact is achieved on the expenditure side

Redistributive impact of tax and spending

Source: Paulus, 2009. 0.00 0.05 0.10 0.15 0.20 0.25 0.30

Change in Gini coefficient

non means-tested benefits means-tested benefits personal taxes social insurance contributions

Transfers = 0.10 Transfers and taxes = 0.15

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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)

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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

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Diminishing Redistributive Impact of Fiscal Policy Since Mid-1990s

However, the redistributive impact of fiscal policy has decreased since the mid-1990s

36.2 26.7 39.2 27.4 39.8 28.3 5 10 15 20 25 30 35 40 45 Market Income (left) Disposable Income (left) Gini coefficient mid-1980s mid-1990s mid-2000s 73.2 52.5 10 20 30 40 50 60 70 80 Fiscal Redistribution (right) Percent Source: Immervoll and Richardson, 2011; OECD, 2011.

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• IV. How effective has fiscal

policy been at reducing inequality in developing countries?

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Levels and Composition of Tax Revenues and Social Spending

Impact of fiscal policy in developing economies is limited by low tax-spending levels…

5 10 15 20 25 30 35 40 Advanced Emerging Europe Latin America Middle East and North Africa Asia and Pacific Sub- Saharan Africa

Percent of GDP

Tax, 2010 or latest Property Corporate Income Indirect 5 10 15 20 25 30 Advanced Emerging Europe Middle East and North Africa Latin America Sub- Saharan Africa Asia and Pacific

Percent of GDP

Social Spending, 2010 or latest Education Health Transfers

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…..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

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8.6 1.7 1.6 0.9 0.6 0.0 4.6 3.0 1.8 3.3 1.1 1.6 13.2 4.7 3.4 4.1 1.8 1.6 2 4 6 8 10 12 14 MENA CEE-CIS Sub-Saharan Africa E.D. Asia LAC Advanced Percent of GDP

Energy price subsides as a percentage of GDP

Pre-tax Tax- subsidies Post-tax

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Bottom quintile, 19.0 Second quintile, 19.7 Third quintile, 20.6 Fourth quintile, 20.1 Top quintile, 20.6

Kerosene

Bottom quintile, 7.2 Second quintile, 11.4 Third quintile, 16.2 Fourth quintile, 22.5 Top quintile, 42.8 Bottom quintile, 3.0 Second quintile, 5.7 Third quintile, 9.7 Fourth quintile, 19.4 Top quintile, 61.3

Gasoline

Bottom quintile, 7.3 Second quintile, 11.7 Third quintile, 16.3 Fourth quintile, 22.6 Top quintile, 42.0

Diesel

Bottom quintile, 3.8 Second quintile, 7.6 Third quintile, 12.6 Fourth quintile, 20.8 Top quintile, 53.8

LPG

Fuel subsidies benefit upper income groups the most… …across all products

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Fiscal policy accounts for nearly 3/4 of Europe

• vs. Latin America Gini difference

Re-distributional impact: Europe vs. Latin America

0.23 0.17 0.05 0.1 0.15 0.2 0.25 Disposable gini difference Fiscal impact Right-side axis 0.52 0.46 0.5 0.27 Latin America Europe 0.1 0.2 0.3 0.4 0.5 0.6 Gross income Disposable income

Source: Goñi, López and Servén, 2008

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Benefit Incidence of Education and Health Public Spending (share of bottom 40 percent)

In-kind public spending has been found to be regressive in many developing economies

10 20 30 40 50 60 70

Chile (1996) Romania (1997) Argentina (1993) Dominican Republic… Bulgaria (1997) Malawi (1997) Macedonia (1996) Mexico (1996) Peru (1994) Mongolia (1995) Kyrgyz Republic (1993) Cote d' Ivoire (1995) Guyana (1993) Panama (1997) Tanzania (1993) South Africa (1993) Mozambique (1996) Bangladesh (2000) Ecuador (1998) Vietnam (1993) Armenia (1996) Kazakhstan (1996) Madagascar (1993) Nepal (1996) Nicaragua (1993) Guinea (1994)

Education Benefit Incidence for Bottom 40% 10 20 30 40 50 60 70 80

Argentina (1993) Chile (1992) Colombia (1992) 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)

Health Benefit Incidence for Bottom 40%

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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

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• V. Lessons for the design of

fiscal policy in developing countries

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Lessons for the design of fiscal policy

In developing economies, the capability of fiscal policy to address income inequality needs to be enhanced This requires improvements on two fronts:

The level of tax and spending needs to be increased The redistributive impact of tax and spending needs to be improved

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Enhancing role of tax policy

Strengthening resource mobilization capacity

Improvement in administrative capacity Expansion of corporate and personal income tax bases (addressing exemptions, loopholes, and tax compliance) Expansion of tax policy instruments (VAT plus excises)

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Enhancing role of public spending

Higher and better targeted spending

Expansion and improved targeting of social assistance (eliminate universal price subsidies) Expansion of health and education Expansion of conditional cash transfers

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THANK YOU THANK YOU THANK YOU THANK YOU

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Change in Gini Coefficient, 1990 to 2005

Change Large Increase (Change ≥ 5) Medium Increase (3 ≤ Change < 5) Small Increase (0 < Change < 3) Small Decrease (-3 < Change < 0) Medium Decrease (-5 < Change ≤ -3) Large Decrease (Change ≤ -5) Latin America and Caribbean 1990-2005 Colombia, Honduras, Paraguay, Venezuela Bolivia, Costa Rica, Uruguay Argentina, Dominican Republic, Guatemala, Jamaica El Salvador, Panama Brazil, Chile, Ecuador, Nicaragua, Peru Belize, Mexico Sub-Saharan Africa 1990-2005 Cote d'Ivoire, Ghana, Niger, Rwanda, South Africa Mozambique, Tanzania Burundi, Madagascar, Zambia Cameroon, Nigeria, Uganda Gambia Burkina Faso, Central African Republic, Ethiopia, Guinea, Guinea-Bissau, Kenya, Lesotho, Malawi, Mali, Namibia, Senegal, Swaziland Asia and Pacific 1990-2005 China, Indonesia, Rep. of Korea, Lao PDR, Nepal, Sri Lanka Bangladesh, Cambodia, Taiwan India, Mongolia, Philippines, Vietnam Thailand Malaysia Middle East and North Africa 1990-2005 Kyrgyz Republic, Tajikistan, Turkmenistan, Uzbekistan Djibouti Egypt, Mauritania, Morocco, Tunisia Pakistan Iran, Jordan

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