Image by VirtualWolf CC 2.0 via Flickr http://bit.ly/2egQPaQ

In recent decades, income inequality has increased in many developed countries. Although fiscal policies are the main tools available to policymakers to address widening inequality, there is mounting evidence that taxes and transfers have become less effective at redistributing income. In Hérault and Azpitarte (2015, 2016) we examine recent trends in income inequality and income redistribution in Australia and explore the many potential factors underlying these trends.

We find that the Gini coefficient of equivalised disposable household income (i.e. post-tax post-transfer income adjusted for household size) increased from 0.28 in 1994/95 to 0.30 in 2009/10, with most of the increase occurring in the 2000s. What is particularly striking in the Australian case is that this increase in disposable income inequality occurred despite a concomitant reduction in the Gini of market (i.e. pre-tax pre-transfer) income from 0.50 to 0.48. How could disposable income inequality increase in this context?

The extent to which changes in market income inequality lead to a more or less equal distribution of disposable incomes depends on the redistributive capacity of taxes and transfers. Progressive tax and welfare systems like the Australian reduce inequality by transferring income from high to low income families.

The 1990s and 2000s were marked by substantial tax-transfer policy reforms most of which were aimed at promoting labour market participation and at reducing welfare dependency. These included cuts in top marginal tax rates and increases in the top tax thresholds that determine the range of income taxed at those rates. Withdrawal rates of most income-tested government benefits were also significantly reduced to limit disincentives to work. The 100 per cent withdrawal rate applicable to most allowance payments prior to 1994 was first reduced to 70 per cent in 1995 and then to 60 per cent in 2006. On top of these changes welfare policy reforms such as the Australians Working Together package of 2003, the 2006 Welfare to Work reform, and even the more recent Building Australia Future Workforce reform in 2011 all increased the conditionality of the system by tightening the access to welfare payments related to unemployment, disability and parenting.

Our results show that the Australia’s tax and transfer system has become less effective at redistributing income over the last two decades and that policy reforms over that period contributed to that change. A standard measure of the redistributive effect of the tax and transfer system is simply to look at the difference between the Gini coefficients of market and disposable incomes. By this measure, we find that between 1994/95 and 2009/10 the Australian tax and transfer system became 20 per cent less effective at redistributing income.

Both taxes and transfers contributed to the decline in redistribution. In the case of transfers, the decline in the redistributive effect was mostly driven by the declining size of transfers relative to total household income. This decline was largely due to the reduced reliance on the welfare system thanks to the employment growth over that period. The redistributive effect of income taxes increased in the late 1990s and declined in the 2000s to return to its level of the mid-1990s by 2009/10. Here it is important to keep in mind that the level of redistribution achieved through the tax system depends both on the progressivity of taxes (i.e., how disproportionately taxes are levied on the rich rather than on the poor) and on the size of the tax system (i.e., how much taxes are levied or what the average tax rate is). We find that tax reforms contributed to make the tax system slightly more progressive but that they also shrunk the size of the system, so that the end result was a substantial decline in the redistributive effect of taxes between 1999/2000 and 2007/08. The overall picture is that while the successive reductions in taper rates and income tax rates led to an overall reduction in effective marginal tax rates, the effect was asymmetric with middle and high-income households benefiting more than low-income households.

Focussing more specifically on the period between 1999/2000 and 2007/08, when most of the inequality changes occurred,  the novel decomposition we develop in Hérault and Azpitarte (2016) explains the apparent Australian paradox of the concomitant reduction in market income inequality and increase in disposable income in the following way. The main driver behind the reduction in market income inequality was the booming labour market that led to a sharp decline in the unemployment rate and to an increase in employment rates. Everything else being equal, this should have led to a reduction in disposable income inequality. Instead, disposable income inequality increased and we show that half of that increase was due to the tax and transfer policy reforms implemented during the 1999-2008 period. This was the single most important factor our study identified, although we found evidence that the increased dispersion of wages and capital income also played a significant role in widening both market and disposable income inequality.

References

Hérault, N. and Azpitarte, F. (2016). Understanding Changes in the Distribution and Redistribution of Income: A Unifying Decomposition Framework, Review of Income and Wealth, 62(2), 266-282.

Hérault, N. and Azpitarte, F. (2015). Recent Trends in Income Redistribution in Australia: Can Changes in the Tax-Benefit System Account for the Decline in Redistribution?, The Economic Record, 91(292), 38-53.

Like or share this piece:

Leave a comment

Your email address will not be published. Required fields are marked *

*