Greater equality ‘harms work incentives’

There is a 'negative and significant' link between income equality and work incentives, says a new academic study of EU countries.

The study used EUROMOD (an EU-wide microsimulation model) to disentangle the role of taxes, benefits and social insurance contributions in influencing income inequality and work incentives – the latter being indicated by marginal effective tax rates (METRs), the share of an increase in earnings lost through higher tax and social insurance contributions and/or lower benefit entitlement.

 

Key findings

  • Tax-benefit systems have a significant effect in reducing income inequality, although to differing degrees across EU countries. Public pensions play a primary role in reducing inequalities arising from original income. Excluding pensions, the component with the strongest impact on income redistribution in most countries is income taxes. In the UK and Ireland means-tested benefits play a comparatively important role.
  • METRs are widely different between countries. The increase in tax liabilities is, on average, the most important component of country-specific METRs: but benefit withdrawal is important at lower incomes in countries that have substantial means-tested programmes.
  • With 'some notable exceptions', there is a negative and significant relationship between Gini coefficients (a standard measure of income inequality) and METRs, both in 2007 levels and in the variation over the period 2007–2010.
  • The authors suggest that this 'trade off' between equity and work incentives should be the subject of further research – not least because policies in some countries, including the UK and Germany, appear to allow the link between income inequality and work incentives to be broken.

Source: Holguer Xavier Jara and Alberto Tumino, 'Tax-benefit systems, income distribution and work incentives in the European Union', International Journal of Microsimulation, Volume 6 Issue 1
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