Recent research by the OECD is unequivocal, if hardly surprising: reducing the fiscal deficit by raising taxes makes society more equal, but doing so by reducing welfare spending makes society more unequal. This holds for all 29 OECD countries studied, although the magnitude varies by country, depending on how large and progressive are their respective tax and welfare systems.
In arriving at their conclusions, the OECD simulated for each country a deficit reduction in the order of 3% of GDP, consisting in the first instance of increased household taxes only, and in the second instance of reductions in cash transfers to households only.
To estimate the impact of these measures on inequality, they calculate the proportional change in the GINI coefficient, a common if imperfect measure of income equality.
With a GINI of 0.287, Ireland’s income distribution is a little below both the mean (0.299) and the median (0.291), meaning Ireland is slightly more equal than both the average and the ‘middle country’ in the OECD.
A package of household tax increases amounting to 3% of GDP reduces an OECD country’s GINI coefficient by 0.009 on average (0.008 being the median), i.e. making it more equal. In Ireland, such measures would reduce the GINI by 0.012, signaling that Ireland’s taxation system is more progressive than the OECD average.
A package of household cash transfer cuts amounting to 3% of GDP increases an OECD country’s GINI coefficient by 0.018 on average (the median being almost identical), i.e. making it more unequal. In Ireland, such measures would increase the GINI by 0.022, again signaling that Ireland’s welfare system is more progressive than the OECD average.
These may sound like very small numbers, but in fact, all else equal, a 0.022 increase in Ireland’s GINI coefficient would see it fall 6 places from 13th most equal of 29 studied to 19th most equal.
Together, these findings show the extent of the trade-off in terms of equity inherent in a government’s decision on how to balance fiscal consolidation measures between taxes and spending. Given the nature of Ireland’s tax and welfare systems, this is even more so the case for Ireland than for the average OECD country.
In Ireland, as I have written on previous occasions, fiscal consolidation began in 2008. Income tax increases were largely front-loaded, meaning that earlier budgets in the deficit cutting cycle were more progressive that those that came later. Although the budget consolidation as a whole – over 7 budgets – is considered to be progressive in terms of their impact on income distribution, this has not been the case for the 2012 and 2013 budgets.
Before the 2011 election, Fine Gael committed to a 4-1 ratio of spending to taxation measures whereas the Labour Party committed to a 1-1 split. In the event, the new coalition agreed to a 3-1 split, although the most recent 2013 budget was characterized by a 2-1 split.
By the OECD’s own admission, this is a rather blunt exercise, and the respective impacts can be moderated through the choices and design of particular tax and welfare measures, but it does illustrate clearly the distributional impact of the choice between tax and welfare measures. Moreover, examining the magnitude of the measures across countries gives a good indication of how progressive are OECD countries’ tax and welfare systems.