Governments ‘can reduce inequality’

Researchers in Germany have concluded that governments are capable of reducing income inequality. They say that the evidence is stronger for the effects of social spending than for progressive taxation.

The research paper analyses the effect of redistributive policies on post-tax inequality in industrialised (OECD) countries over the period 1981–2005.

Key findings

  • Radical and liberal welfare states are characterised by more inequality than social-democratic or conservative ones. The large rise in inequality in eastern European states since the breakdown of socialism there, from the late 1980s onwards, supports this observation.
  • There is evidence that government social expenditure is most effective at reducing inequality. A one per cent increase in government spending is linked to a 0.3 per cent drop in inequality.
  • The degree of progressivity in the tax system is less important for reducing inequality. This is because higher tax progressivity may induce strong behavioural effects, which tend to increase pre-tax inequality and hence work against the direct inequality-reducing effect.
  • Although the USA has one of the most progressive income tax systems in the world, very little redistribution is conducted through social benefits. In contrast, European welfare states rely (on average) much more on benefits and government expenditure.

The full paper (Philipp Doerrenberg and Andreas Peichl, The Impact of Redistributive Policies on Inequality in OECD Countries, Discussion Paper 6505, Institute for the Study of Labor, Bonn) can be read here.