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A stability-oriented monetary policy cushions the impact of negative shocks on poorer households. As noted above, inflation has a direct effect on the distribution of income through changes in the real value of assets. An unexpected increase in inflation hurts savers and benefits borrowers. Inflation hurts in particular richer and older households, as they hold a larger share of their wealth in financial assets, but it is also particularly harmful to the poorest social groups, who tend to hold a larger proportion of their savings in cash. In addition, monetary policy shocks and surprise inflation can have an impact on inequality through their effect on income from labour and on job losses for less-skilled workers. The negative redistributive impacts of monetary policies will be lower where the monetary authorities succeed in countering macroeconomic cycles, rather than overreacting when they do occur.

Nevertheless, macroeconomic stability does not necessarily ensure improvements in the distribution of income. This was the case during the period known as the “great moderation”, when economic growth was steady, but income gains accrued disproportionately to richer households, as discussed in Chapter 1. This was because of a combination of factors, not least financial innovation and rising returns to high skills, which favoured the accumulation of income among top earners, at a time when monetary policy focused on the pursuit of consumer price stability and was unable to prevent an asset-price bubble developing.

Monetary policy in developing and emerging market economies often targets the exchange rate in addition to inflation. Efforts to enhance price competitiveness by targeting an undervalued exchange rate tend to favour firms and workers in the tradable sector to the detriment of those operating in nontraded sectors and consumers in general, who pay higher prices for imported goods. Over time, inflationary pressures tend to build up, poorer households are disproportionately hit, and corrective adjustments in the real exchange rate ultimately shift income back to the non-tradable sector. Financial repression, for example through mandated portfolio allocations for banks, may be used to reduce the cost of sterilised interventions in foreign exchange markets (Prasad, 2013).

The effects of capital controls on the distribution of income need to be better understood. In some countries, controls are introduced on capital inflows in periods of abundant international liquidity to raise the relative cost of foreign investment that could be destabilising in shallow capital markets, and would lead to an appreciation of the domestic currency and a build-up of vulnerabilities. Controls are also introduced on capital outflows to prevent capital flight in periods of financial vulnerability. Although such controls might work in the short term, they can often be circumvented, making their effectiveness shortlived. More importantly, by altering the relative price of domestic and foreign financial assets, capital controls affect the funding costs of firms differently, often to the detriment of smaller enterprises that cannot easily circumvent the controls and rely on more traditional sources of credit.

Fiscal policy is relevant to both redistribution and economic stability Fiscal policy has played a crucial role in mitigating income inequality in advanced economies.

This has been achieved essentially through the tax-benefit system, which relies on progressive taxation to finance redistributive transfers to poorer individuals and households, as well as the provision of public goods and services, which creates to varying degrees, depending essentially on programme design and implementation, better opportunities for individuals to participate in economic life. Fiscal policy also plays a crucial role in helping to stabilise the economy over the business cycle, which has a bearing on redistribution, as discussed above.

Although less redistributive than in the past, tax-benefit systems still play an important role in mitigating earnings inequality in OECD countries. In the late 2000s, income inequality among the working-age population was on average 25% lower after taxes and transfers (Figure 3.1) (Joumard, Pisu and Bloch, 2012). The fall in the Gini coefficient before and after taxes and transfers for the whole population is substantial, as much as 0.2 points on average for OECD countries. In practice, about twothirds of the redistribution has been the result of cash transfers to targeted households in the form of child allowances, public pensions and the like, and one third the result of progressive tax schedules. If in-kind benefits (education, health care and social housing services) are added, the Gini coefficient falls by a further 0.07 points on average for OECD countries (OECD 2011a). Nevertheless, this substantial equalising effect on net incomes has to be set against a generally rising trend in pre-tax earnings inequality in most OECD countries.

–  –  –

Source: OECD Income Distribution Database.

Note: Data refer to the working-age population. Incomes refer to household equivalised incomes.

1995 refers to 1994 for Greece, United Kingdom and to 1996 for Czech Republic, France, Luxembourg.

2010 refers to 2009 for Japan, New Zealand and Switzerland and to 2011 for Chile.

Rising inequality is motivating reform of tax-benefit systems in many countries. In 2013, Greece removed several tax deductions and credits from the personal income tax system, such as for mortgage interest deductibility, and eliminated the tax-free threshold that favours the self-employed (OECD, 2013n).

In Indonesia, the government reduced the notoriously regressive fuel subsidy (OECD, 2012f) in June 2013.

There is, nevertheless, much room for making tax policy more redistributive and efficient at the same time.

For example, in the United States, where the level of income inequalities is among the highest in the OECD, there is a high degree of scope for reducing tax expenditures, which in some cases benefit higherincome individuals and larger firms (OECD, 2012g ) (Box 3.1).

Country experiences are instructive. In Colombia, the government introduced a tax reform in 2012 aimed at strengthening the redistributive impact of taxes, promoting formal employment and reducing tax avoidance and evasion. As a result of the reform the poor and middle classes have seen their effective income tax rate fall from 6 to 0%, while a maximum rate finally passed for the richest segment of the population was 15% (the proposal was for 25%) (OECD, 2013m). The 2013 reform of social assistance in Denmark has focused on helping youth with low educational attainment to escape from the inactivity trap (OECD 2014f). In particular, individuals under the age of 30 are given financial support to undertake education instead of standard social assistance. In Estonia, the government introduced a means-tested benefit for to help university students from disadvantaged socio-economic background coping with the cost of living while pursuing higher education (OECD, 2012e).

Box 3.1. Reforming the tax and transfer systems in the US to address rising income inequalities Compared with the OECD average, the United States has a significantly higher level of income inequality of over the whole population, and one that has risen faster over time. Whereas real average household market income in the US rose by 34% in the 30 years up to 2009, real median household market income rose by only 14%: indeed, the share of the top quintile increased by 10 percentage points. The inequality of disposable income is now the fourth highest among OECD countries, behind Chile, Mexico and Turkey. After redistribution mechanisms – household taxes and cash transfers – are taken into account, the US also has the fourth highest relative poverty rate among OECD countries, behind Mexico, Israel and Chile. The impact of household taxes on reducing inequality (as measured by the Gini coefficient) is in fact greater than in most OECD countries (the top 1% of tax payers in 2009 paid 22% of federal taxes), but the impact of cash transfers is much lower (Denk et. al.

2013). As in other countries, the distribution of wealth is even more unequal than the distribution of income. It is estimated that the top 1% of households owned 35% of net worth in 2004, and the bottom 40% owned less than 1% (Wolff, 2007). One consequence of the high and rising inequality of both income and wealth, combined with lowered taxes and duties on intergenerational transfers, is that intergenerational social mobility has fallen significantly, and is now lower on several measures than in many European countries (Causa and Johansson, 2009).

The causes of rising inequality are various (Chapter 2), and policies to mitigate it can also vary between

countries. In the particular case of the United States, to foster Inclusive Growth, Denk et al (2013) suggest:

Direct more resources towards the education of disadvantaged children, and upgrade teachers’ salaries to attract more able candidates;

Raise tax rates on income from capital to discourage the richest households from taking advantage of tax loopholes, without distorting incentives to invest to an unacceptable extent;

Cap tax expenditure rates on for example mortgage interest deductions or employer-financed health cover to 28%;

Lower incentives on corporations to move their production abroad to take advantage of lower taxes there;

Reform social programmes to target the poorest households with means-tested transfers, rather than specific demographic groups.

Protecting the redistributive role of fiscal policies is likely to become more challenging in the years to come. This is because of a number of factors, not least population ageing and the need to maintain fiscal consolidation efforts over the medium term, which will put pressure on national budgets and constrain their ability to redistribute income towards less affluent social groups. At the same time, enhanced mobility across national frontiers for both firms and high-earning individuals continues to put pressure on governments to reduce the tax burden on corporate profits, higher levels of personal income and other mobile tax bases. All of which has made income tax progressively less redistributive, despite international efforts to curb tax evasion, profit shifting and base erosion (Box 3.2).

A full assessment of the distributional effects of consolidation packages would need to consider dynamic measures, such as life-time income distribution and equality of opportunity, along with behavioural responses and interactions with other policies. Increasing direct taxes on incomes would reduce income inequality, while cutting transfers by the same amount would have a potentially greater and opposite effect. However, raising progressive labour income taxes could have adverse effects on long-run growth, especially in countries where the tax burden on income is already high (Arnold, Brys and Johannsson, 2011). Cuts in government wages and employment can yield fast consolidation gains but need to be accompanied by increases in efficiency of service delivery, for example in the areas of health and education, to avoid reductions in public services hitting vulnerable social groups disproportionately. Cuts in unemployment-related and disability benefits will likely hit poorer people in the first place but may have less adverse effects on inequality in the long run once employment increases in response to a better incentive structure (OECD, 2013f). Those tax expenditures that mainly benefit higher income groups can be reduced, and taxes on immovable property increased. Higher rates of taxes and duties on intergenerational transfers of wealth would not only increase tax revenue, but also make for a more equitable and sustainable distribution of wealth.

Box 3.2: Combating tax avoidance and evasion

In an interconnected world, national tax laws have not kept pace with global corporations and fluid capital, leaving gaps that can be exploited by companies who avoid taxation in their home countries by pushing profits abroad to low or no tax jurisdictions. This activity, which is referred to as base erosion and profit shifting (BEPS), undermines the fairness and integrity of tax systems, costs governments money, distorts competition, leads to inefficient allocation of resources, and undermines voluntary compliance by all taxpayers. Because BEPS strategies take advantage of interactions between the tax rules of multiple jurisdictions, only an internationally coordinated effort can effectively respond to this issue. At the request of G20 Finance Ministers, in July 2013, the OECD launched an Action Plan on BEPS, identifying 15 specific actions to address this issue in a comprehensive and coordinated way, following the core principles of coherence, substance, and transparency. The actions outlined in the plan will be delivered in 2014 and 2015 by the joint OECD/G20 BEPS Project, which involves all OECD members and G20 countries on an equal footing.

Globalisation has also made it easier for all taxpayers to make, hold and manage investments through financial institutions outside of their country of residence. Vast amounts of money are kept offshore and go untaxed to the extent that taxpayers fail to comply with tax obligations in their home jurisdiction. Co-operation between tax administrations is critical in the fight against tax evasion and a key aspect of that cooperation is exchange of information. Responding to a call from the G20 the OECD, working with G20 countries, has developed a single global standard for automatic exchange of information. The standard obliges countries and jurisdictions to exchange information obtained from their banks and financial institutions automatically on an annual basis. Further, the OECD is expected to deliver a detailed Commentary on the new standard, as well as technical solutions to implement the actual information exchanges, during a meeting of G20 Finance Ministers in September 2014.

Source: http://oecd.org/tax/beps.htm and http://oecd.org/ctp/exchange-of-tax-information/automaticexchange.htm Better targeted fiscal policies can improve outcomes for the disadvantaged. Tax policy can help redistribute incomes, and spending on public services, such as health care and education, promotes economic growth and important social outcomes in various ways. But fiscal policies also have a bearing on the distribution on income and non-income outcomes in other ways, notably by financing social protection systems that help individuals and households cope with disability, unemployment, and inadequate or unhealthy accommodation. Transfers and public spending can increase opportunities for upward social mobility, provide social safety nets, and build a more inclusive social infrastructure.

There is a lot of scope for improving the provision of cost-effective social services in a fiscally sustainable manner in developing countries and emerging market economies. As noted in Chapter 1, inequality of incomes is, in general, considerably higher in emerging market economies than in OECD countries. Informal employment is also widespread, which limits the extent to which governments can rely on progressive taxation to redistribute income and reach the intended beneficiaries of social programmes to improve outcomes along the non-income dimensions that matter for well-being. Taxes on goods and services, customs duties and special taxes on luxury goods play a larger role in those countries than in the OECD area. The deliberate use of fiscal policy to stabilise the economy is limited by the comparatively small size of the public sector and the limited size of automatic stabilisers in the form of unemployment compensation and progressive taxation. On the other hand, as per capita incomes have risen, tax revenues have risen even faster, and there has been more emphasis on social programmes aimed at poorer households, a phenomenon which has been observed in several Latin American countries (Box 3.3).

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