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Tax Progressivity and Recent Evolution of the Finnish Income Inequality

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  • Sullström, Risto
  • Riihelä, Marja
  • Suoniemi, Ilpo

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.

Suggested Citation

  • Sullström, Risto & Riihelä, Marja & Suoniemi, Ilpo, 2008. "Tax Progressivity and Recent Evolution of the Finnish Income Inequality," Discussion Papers 460, VATT Institute for Economic Research.
  • Handle: RePEc:fer:dpaper:460
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    References listed on IDEAS

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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. Veli-Matti Ritakallio & Olof Bäckman & Johan Fritzell, 2011. "Income inequality and poverty: do the Nordic countries still constitute a family of their own?," LIS Working papers 563, LIS Cross-National Data Center in Luxembourg.
    3. Immervoll, Herwig & Richardson, Linda, 2011. "Redistribution Policy and Inequality Reduction in OECD Countries: What Has Changed in Two Decades?," IZA Discussion Papers 6030, Institute for the Study of Labor (IZA).
    4. Matikka, Tuomas, 2014. "Taxable Income Elasticity and the Anatomy of Behavioral Response: Evidence from Finland," Working Papers 55, VATT Institute for Economic Research.
    5. Moździerz Anna, 2015. "Tax Policy and Income Inequality in the Visegrad Countries," Naše gospodarstvo/Our economy, De Gruyter Open, vol. 61(6), pages 12-18, December.
    6. 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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    Keywords

    Income inequality; Tax progressivity; Decomposition; Gini coefficient; Income distribution; Tulonjako; Taxation; Verotus; Taxation and Social Transfers; Julkisen talouden rahoitus ja tulonsiirrot;

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