Welfare states have reduced the recent growth in income inequality by around two-thirds through benefit systems and social transfers, according to new study. In contrast, tax systems over the period examined actually contributed to greater inequality.

The paper investigates income distribution and redistribution attributed to social transfers and taxes across 20 developed countries from around 1985 to the mid-2000s, based on household income data from the Luxembourg Income Study. It differs from earlier studies in that the total population is taken into consideration, instead of just those of working age.  

Key findings

• Tax-benefit systems offset two-thirds of the average increase in primary income inequality.
• Tax-benefit systems in the mid-2000s were even more effective at reducing inequality than in the mid-1990s – contrary to the claim that reduced redistribution has been a main driver of widening income gaps.
• Public pensions accounted for 60 per cent of the increase in redistribution during the period 1985–2005 for a subset of countries considered.
• Social assistance accounted for a further 20 per cent, and benefits for sickness/disease/disability accounted for around 13 per cent.
• Conversely, taxes slowed down redistribution by 17 per cent during 1985–2005.

The authors point out that, as market income inequality rises, tax-benefit systems will automatically have a more redistributive impact, because of their in-built progressivity. Future research should therefore consider the impact of specific policy reforms, as opposed to automatic effects, in changing the redistributive power of welfare states.

Source: Koen Caminada, Kees Goudswaard and Chen Wang, Disentangling Income Inequality and the Redistributive Effect of Taxes and Transfers in 20 LIS Countries over Time: Evidence from the LIS Data, Working Paper 581, Luxembourg Income Study
Link: Paper