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The Composition Effects of Tax-Based Consolidations on Income Inequality

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  • Ciminelli, Gabriele
  • Ernst, Ekkehard
  • Giuliodori, Massimo
  • Merola, Rossana

Abstract

Many advanced economies have recently embarked on fiscal austerity. As this has come at a time of high and rising income disparities, policy-makers have fretted about the inequality effects of fiscal consolidations. We shed new light on this issue by empirically investigating the (composition) effects of tax-based consolidations on income inequality, output and labour market conditions for a sample of 16 OECD countries over the period 1978-2012. We find that tax-based consolidations reduce income inequality, but at the cost of weaker economic activity. However, tax composition does matter. Indirect taxes reduce income inequality by more than direct taxes, possibly due to the operation of a positive labour supply channel. Higher indirect taxes increase the price of the consumption basket and create incentives for agents to increase their labour supply. We find this effect to be stronger for middle aged women. Looking at specific instruments, general consumption taxes and personal taxes are the most suited to reduce inequality while at the same time minimizing the equity-efficiency trade-off.

Suggested Citation

  • Ciminelli, Gabriele & Ernst, Ekkehard & Giuliodori, Massimo & Merola, Rossana, 2017. "The Composition Effects of Tax-Based Consolidations on Income Inequality," GLO Discussion Paper Series 25, Global Labor Organization (GLO).
  • Handle: RePEc:zbw:glodps:25
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    References listed on IDEAS

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    1. Afonso, António & Jalles, João Tovar, 2014. "Assessing fiscal episodes," Economic Modelling, Elsevier, vol. 37(C), pages 255-270.
    2. Athreya, Kartik B. & Owens, Andrew & Romero, Jessica Sackett & Schwartzman, Felipe, 2017. "Does Redistribution Increase Output?," Richmond Fed Economic Brief, Federal Reserve Bank of Richmond, issue January, pages 1-4.
    3. Luca Agnello & Ricardo M. Sousa, 2014. "How Does Fiscal Consolidation Impact on Income Inequality?," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 60(4), pages 702-726, December.
    4. Cecilia Garcia-Penalosa & Eve Caroli & Philippe Aghion, 1999. "Inequality and Economic Growth: The Perspective of the New Growth Theories," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1615-1660, December.
    5. Jean-Paul Fitoussi & Francesco Saraceno, 2009. "How Deep is a Crisis? Policy Responses and Structural Factors Behind Diverging Performances," Documents de Travail de l'OFCE 2009-31, Observatoire Francais des Conjonctures Economiques (OFCE).
    6. Francesca Bastagli & David Coady & Sanjeev Gupta, 2012. "Income Inequality and Fiscal Policy (2nd Edition)," IMF Staff Discussion Notes 12/08R, International Monetary Fund.
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    Cited by:

    1. Tingyun Chen & Jean-Jacques Hallaert & Alexander Pitt & Haonan Qu & Maximilien Queyranne & Alaina Rhee & Anna Shabunina & Jérôme Vandenbussche & Irene Yackovlev, 2018. "Inequality and Poverty across Generations in the European Union," IMF Staff Discussion Notes 18/01, International Monetary Fund.

    More about this item

    Keywords

    Income distribution; Tax-based consolidation; Fiscal consolidation; Labour force participation; Tax composition;

    JEL classification:

    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • O1 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development

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