Impact of fiscal policy on income distribution

This part of the European Commission's report on public finances in EMU 2017 analyses the impact of fiscal policy on income distribution in the European Union. The analysis tries to capture not only the direct effect of the tax and benefit system on disposable income, but also the total effect of fiscal policy on income inequality by taking into account behavioural and macroeconomic feedback effects. The main findings can be summarised as follows: First, government redistribution via the tax and benefit system had a direct effect in reducing income inequality in the EU by almost one-third. New panel data analysis reveals that the total effect of fiscal policy on inequality reduction is smaller than its direct effect, mostly due to the behavioural responses and macroeconomic effects. Second, fiscal policy is also important in stabilising income and consumption across income deciles over the economic cycle. The degree of direct automatic stabilisation is fairly high in the EU in 2014 according to new micro-simulations based on EUROMOD. The total automatic stabilisation effect is smaller than its direct effect according to new macro-simulations for Italy based on QUEST. Overall, the chapter makes clear that fiscal policy needs to be carefully designed to balance equity, stabilisation and efficiency considerations, taking into account potentially harmful indirect effects.