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Tax Progressivity and Recent Evolution of the Finnish Income Inequality

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  • Marja Riihelä
  • Risto Sullström
  • Ilpo Suoniemi

Abstract

After the Economic Crisis in early 1990s the Finnish economy has recovered rapidly, and simultaneously a major period of equalization from the mid 1970s to the mid 1990s has been reversed, taking the levels of the Gini coefficient in a few years back to levels of inequality found 30 years ago. The paper examines how changes in Government policy, and in particular, in the incentives introduced by tax reforms have influenced income inequality. The paper introduces a decomposition of the Gini and concentration coefficients by population groups which are calculated for before- and after-tax incomes to consider evolution of income inequality and tax progressivity in Finland over the period 1990?2004. Decompositions of the Gini coefficient of after-tax income by income sources give little information on the effects of taxation. In contrast, popular measures of tax progressivity (Reynolds and Smolensky 1977) show a significant decrease. Our decomposition of the progressivity measure by income deciles focuses on changes in tax treatment of the income deciles in the ten year period after the mid 1990s. The changes in the decile shares of before-tax and after-tax income among those in the highest before-tax income deciles are the main factors that lie behind the recent change in tax progressivity, and play an important role in explaining the recent surge in inequality. These changes have been accompanied with a change in the composition of factor income. There has been an unprecedented increase in capital income which has mainly accrued to the population groups at the high end of the income distribution after the mid 1990s. The change is most clearly seen among those in the top income percentage. The 1993 Finnish tax reform introducing the Nordic dual income tax model, and creating strong incentives to shift labour income to capital income for those in the highest marginal tax brackets, is among the key policy decisions responsible for this trend. Interestingly enough, but consistent with the income shifting hypothesis, we find no increase in horizontal inequality in response to the introduction of the dual income tax.

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Bibliographic Info

Paper provided by Government Institute for Economic Research Finland (VATT) in its series Discussion Papers with number 460.

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Date of creation: 17 Dec 2008
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Handle: RePEc:fer:dpaper:460

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Keywords: Income inequality; Tax progressivity; Decomposition; Gini coefficient;

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References

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  1. Lerman, Robert I & Yitzhaki, Shlomo, 1985. "Income Inequality Effects by Income," The Review of Economics and Statistics, MIT Press, vol. 67(1), pages 151-56, February.
  2. Tobias Lindhe & Jan Södersten & Ann �berg, 2004. "Economic Effects of Taxing Different Organizational Forms under the Nordic Dual Income Tax," International Tax and Public Finance, Springer, vol. 11(4), pages 469-485, 08.
  3. Jenkins, Stephen P, 1995. "Accounting for Inequality Trends: Decomposition Analyses for the UK, 1971-86," Economica, London School of Economics and Political Science, vol. 62(245), pages 29-63, February.
  4. Shorrocks, A F, 1982. "Inequality Decomposition by Factor Components," Econometrica, Econometric Society, vol. 50(1), pages 193-211, January.
  5. Johnson, Paul, 1996. "The Assessment: Inequality," Oxford Review of Economic Policy, Oxford University Press, vol. 12(1), pages 1-14, Spring.
  6. Atkinson, Anthony B., 1970. "On the measurement of inequality," Journal of Economic Theory, Elsevier, vol. 2(3), pages 244-263, September.
  7. Tomi Kyyrä & Mika Maliranta, 2006. "The Micro-Level Dynamics of Declining Labour Share: Lessons from the Finnish Great Leap," Discussion Papers 406, Government Institute for Economic Research Finland (VATT).
  8. Thomas Piketty & Emmanuel Saez, 2003. "Income Inequality In The United States, 1913-1998," The Quarterly Journal of Economics, MIT Press, vol. 118(1), pages 1-39, February.
  9. Atkinson, A B, 1997. "Bringing Income Distribution in from the Cold," Economic Journal, Royal Economic Society, vol. 107(441), pages 297-321, March.
  10. Shorrocks, A F, 1980. "The Class of Additively Decomposable Inequality Measures," Econometrica, Econometric Society, vol. 48(3), pages 613-25, April.
  11. Kakwani, Nanok C, 1977. "Measurement of Tax Progressivity: An International Comparison," Economic Journal, Royal Economic Society, vol. 87(345), pages 71-80, March.
  12. Anthony B. Atkinson, 2000. "The Changing Distribution of Income: Evidence and Explanations," German Economic Review, Verein für Socialpolitik, vol. 1(1), pages 3-18, 02.
  13. Thomas Piketty, 2003. "Income Inequality in France, 1901-1998," Journal of Political Economy, University of Chicago Press, vol. 111(5), pages 1004-1042, October.
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Cited by:
  1. Jorge Martínez-Vázquez & Violeta Vulovic & Blanca Moreno Dodson, 2012. "The Impact of Tax and Expenditure Policies on Income Distribution: Evidence from a Large Panel of Countries," Hacienda Pública Española, IEF, vol. 200(1), pages 95-130, March.
  2. Herwig Immervoll & Linda Richardson, 2011. "Redistribution Policy and Inequality Reduction in OECD Countries: What Has Changed in Two Decades?," OECD Social, Employment and Migration Working Papers 122, OECD Publishing.
  3. Tuomas Matikka, 2014. "Taxable Income Elasticity and the Anatomy of Behavioral Response: Evidence from Finland," Working Papers 55, Government Institute for Economic Research Finland (VATT).
  4. Johan Fritzell & Jennie Bacchus-hertzman & O. Bäckman & I. Borg & T. Ferrarini & K. Nelson, 2010. "GINI Country Report: Growing Inequalities and their Impacts in Sweden," GINI Country Reports sweden, AIAS, Amsterdam Institute for Advanced Labour Studies.

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