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Redistributive Implications of Fiscal Policy

Income Redistribution or Poverty Alleviation

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Scheme of Presentation

• Introduction

• Concept of equity in fiscal policy

• Redistributive effects of tax policy

• Progressivity of expenditures

• Income Redistribution versus poverty alleviation

• Pro-poor expenditures: some counter-intuitive findings.

• Concluding remarks

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Introduction

• Evolution of concept of equity in tax policy

• Horizontal and vertical equity concepts. Uneasy case for progressive taxation

• Limited effectiveness of tax/expenditure policy on redistribution

• Calibration of equitable fiscal policy- need to shift emphasis to human development and poverty alleviation

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Concept of Equity in Tax Policy

• Emphasis on vertical equity-achieving more equal distribution of incomes;

• High and differentiated tax rates• Developed countries: differentiation of direct taxes• Developing countries: differentiation in indirect

taxes.• Transitional economies: administered prices

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Redistributive Effects of Tax Policy

• Pechman - Okhner Study for US– Conclusion- US Tax system is not significantly progressive

– Tax burden - 25% of family income

– Top decile reduction 2.06 percentage points

– Improvement in the lowest decile 0.12 percentage point.

– Gini coefficient:– Most progressive: 0.4367 0.4158

– Least progressive: 0.4252 0.4240

– Effective tax rate: – MP 21.9% 25.3%

– LP 28.2% 23.3%

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Effective Tax Rates in United StatesCentral,State and Local taxes

0

5

10

15

20

25

30

Deciles

Tax

Rev

enue

/Hou

seho

ld

Inco

me

Per

cent

age

Most Progressive Assumption

Least Progressive Assumption

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Redistributive Effects of Tax Policy

• Progressivity of Tax System in Chile– tax System close to proportional– Gini coefficient moderative regressive.– Insensitivity of income distribution to the tax

system.

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Effective Tax Rates in United StatesTax Progressivity in Chile

0

24

68

1012

1416

18

Deciles

Tax

es a

s P

erce

nta

ge

of

Gro

up

Inco

me

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Progressivity of Expenditures

• Transfers have bigger influence than taxes in redistribution.

• Distribution of incomes is quite insensitive to both tax and expenditures.

• Chile’s case distribution of transfers progressive 37.5% poorest quintile 28.1% next quintile; 3.2% richest quintile.

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Political Economy of Government Budgets

• Neither tax nor expenditure system is likely to alter basic pattern of income distribution

• Attempts to modify income distribution was fashionable half a century ago.

• Confiscatory tax rates: India 92%; US 95%; UK 91%.

• Efficient tax system: optimal taxation

• Expenditure has greater potential: public education and medical care. Middle income groups also benefit and access higher education better.

• Income distribution changes achieved is not much

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Political Economy of Redistribution

• Role of education in redistribution - socioeconomic mobility, demographic transition, targeting, productivity,

• Should the governments bother to redistribute?– Calibrating non-regressive taxes– Incidence assumptions- corporation tax

• More desirable option: reducing poverty.

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Returns to Rural Investments in India

Expenditure Returns in Rs perRupee spending

No. of poor reducedper Mn. Rs

R&D 13.45 84.5Irrigation 1.36 9.7Roads 5.31 123.8Education 1.39 41Power 0.26 3.8Soil and water conservation 0.96 22.6Health 0.84 25.5Anti-poverty programss 1.09 17.8

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Returns to Rural Investment in China

Coastal Central Western AverageReturns toAg GDP

Yuan per Yuan Expenditure

R&D 8.6 10.02 12.69 9.59Irrigation 2.39 1.75 1.56 1.88Roads 1.67 3.84 1.92 2.12Education 3.53 3.66 3.28 3.71Electricity 0.55 0.63 0.4 0.54Telephone 1.58 2.64 1.99 1.91

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Returns to Rural Investment in China

Coastal Central Western AverageReturns toAg GDP

No. of poor reduced per 10000 Yuan expenditure

R&D 1.99 4.4 33.12 6.79Irrigation 0.55 0.77 4.06 1.33Roads 0.83 3.61 10.73 3.22Education 2.73 5.38 28.66 8.8Electricity 0.76 1.65 6.17 2.27Telephone 0.6 1.9 8.51 2.21Povertyloan

0.88 0.75 1.49 1.13

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Concluding Remarks

• Equity in fiscal policy: Shift of emphasis from “reducing the incomes of the rich” to “increasing the incomes of the poor”.

• Progressive rate schedule need not necessarily result in an equitable tax system

• Income redistribution better achieved through expenditure side

• Shift of emphasis from income redistribution to poverty alleviation.

• Need to avoid regressive tax policies to finance anti poverty interventions.

• Direct spending on anti-poverty interventions is not necessarily the most efficient way of reducing poverty.