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Income Inequality and Fiscal Policy

Summary

Income inequality has increased in most advanced and many developing economies over recent decades, reflecting a range of factors including globalization and technological change. Even more striking is the large variation in average disposable (post-tax-and-transfer) income inequality across regions, much of which can be accounted for by differences in the level and progressivity of tax and spending policies. In advanced economies, fiscal policy has played a significant role in reducing income inequality, especially on the expenditure side but also through progressive income taxation. However, reforms since the mid-1990s have lessened the generosity of social benefits and the progressivity of income tax systems in these economies making fiscal policy less redistributive.

In the context of fiscal consolidation in many economies, tax and spending measures should enhance or maintain the distributive effects of fiscal policy while supporting economic efficiency. Such measures include reducing opportunities for tax evasion and avoidance, increasing the progressivity of income taxes over higher income brackets, cutting unproductive expenditures, and expanding means-tested programs. Enhancing the distributive impact of fiscal policy in developing economies will require improving their capacity to raise tax revenues and to spend those resources more efficiently and equitably. Resource mobilization should focus on broadening income and consumption tax bases and expanding corporate and personal income taxes by reducing tax exemptions and improving compliance. Expenditure reforms should focus on reducing universal price subsidies, improving the capacity to implement better targeted transfers, and gradually expanding social insurance systems.

To download the PDF versuon of the working paper click here.


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