Decomposing income polarization and tax-benefit changes across 31 European countries and Europe wide, 2004-2012

Polarization is an interesting additional social indicator for analyzing income inequality and poverty across countries, as it captures the phenomenon of ‘clustering around extreme poles’. Rising income polarization can be harmful since it is closely linked to poverty, social exclusion, social tension and social unrest (Brzezinski, 2013). However, so far little literature has been devoted to the changes in income polarization across countries over time, especially within Europe. Moreover, not much is known about whether and to what extent market income and the tax-transfer system contribute to changes of polarization. This paper provides theoretical and empirical insights into a relatively new dimension of income distribution: polarization. Rising income polarization has been observed outside Europe, but within the EU, polarization is relatively unexplored. We therefore broaden the analysis using micro-data from EU-SILC to 28 EU countries and 3 non-EU countries over the period 2004-2012. The paper estimates income polarization and decomposes the estimated polarization by country clusters, and Europe-wide, using a decomposition technique we developed. The main conclusions are: (1) Income polarization is rather stable over the decade in European countries, and Europe-wide. It was rising among West-EU15 countries in the sub-period 2004-2008, but declining afterwards. The opposite development is witnessed for CEE New Member States. Despite the Great Recession we do not find a sizeable increase in income polarization. (2) The causes of changes in polarization between 2004 and 2012 vary to a large extent across countries – no general pattern is found, although polarization was upward driven by market income (mainly capital income), while tax-benefit systems were polarization-reducing.