Parallel session IARIW 2014

1. What makes personal income taxes
progressive? A decomposition across
European Countries using EUROMOD
Gerlinde Verbist & Francesco Figari
Centre for Social Policy, University of Antwerp
University of Insubria & ISER – University of Essex
Discussant: Richard Tonkin, UK Office for National Statistics

2. Introduction
• EUROMOD used to compare redistributive
effect of personal income taxes (PIT) in EU-15
• Structure of paper/presentation:
1) Inequality and redistributive impact of taxes
2) Methods
3) EUROMOD
4) Results
5) Conclusions

3. Inequality and redistributive impact of
taxes
• Fuest et al. (2012) personal income taxes (PIT)
important source of inequality reduction
• Verbist & Figari (2013) strong negative relationship
between progressivity and tax levels – trade off

4. Inequality and redistributive impact of
taxes
• What factors can influence redistributive effect
of PIT?
• Structure of bands
• Tax rates
• Exemptions, allowances deductions & credits
• Changes to underlying income distribution
• Consequences of tax reforms often less clear
than may appear

5. Methods
• Redistributive impact: Reynolds-Smolensky (1977)
index:
RS = GX – CX-T
• Progressivity: Kakwani (1977) index:
• ΠT = CT – GX

6. Methods
• Progressivity can be decomposed over different
factors:
• Pre-tax income: X
• Tax-exempt income: E
• Tax allowances: A
• Tax deductions: D(X)
• Rate schedule: r(.)
• Tax credits: K
• Net income (N) defined as:
N = X – [r(X – E – A – D(X)] – K]
N = X – Tpit

7. Methods
• Net progressivity:
• Gross progressivity = direct progressivity + indirect
progressivity:

8. EUROMOD
• Europe-wide tax/benefit microsimulation model
• Based on EU-SILC for most countries
• Uses underlying data and tax/benefit rules to simulate:
• Personal Income Taxes (PIT)
• Social insurance contributions
• Other direct taxes
• Cash benefit entitlements
• Allows identification of different tax components
• Current paper focuses on PIT

9. EUROMOD

10. EUROMOD
• Assumptions and caveats:
• Assume full tax compliance and 100% benefit take-up
(how different would results be if this assumption
changed?)
• Don’t account for taxes paid on benefits (would this
have a big impact in some countries?)
• Behavioural decisions not considered
• Look at redistribution at a fixed point in time

11. Results

12. Results
• Rate structure most important factor in most countries
• In 10 countries rate structure accounts for majority of total progressivity
• 80%+ in Austria, Denmark, France, Greece & Luxembourg
• Strong effect from exemptions/allowances in France, Ireland &
UK
• Strong effect from deductions in Portugal & Spain
• Deductions also pro-poor in Finland, Germany and Sweden. Pro-rich in
UK, Ireland & Netherlands
• Strong positive effect of tax credits in Belgium, Ireland Italy and
Spain – negative in France
• No relationship between number of tax bands and
progressivity? Probably, though ΠR low (not high – p.13) for
Sweden

13. Results
• Three groups of countries:
• Rate structure countries: Austria, Denmark, Finland, France
Germany, Greece, Luxembourg & Netherlands
• Tax base composition countries: Portugal, Sweden & UK
• Mixed structure countries: Belgium, Ireland, Italy & Spain
• Groupings changed from 1998 (Verbist, 1998)

14. Results – zero rate
• Attempt to isolate effect of zero rate:
• Basic allowance (e.g. UK)
• Zero-band rate and allowance (e.g. Sweden)
• Basic tax credit (e.g. Ireland)
• No zero-taxed part (e.g. Italy)
• 2 approaches:
• Integrate zero-taxed part as zero-band rate
• Split out zero-taxed part
• Zero-rate in Ireland and UK have similar contribution to overall
progressivity
• In Sweden residual rate effect is primary driver

15. Results – increasing the top rate
• No simple relationship between top rate and PIT
progressivity
• Simulate 5pp increase in top rate
• Progressivity up in all countries
• Impact varies widely – strongest increase in
Denmark/Sweden, also Luxembourg & UK
• Impact small/negligible in Southern Europe and France
• Generally larger impact in countries where more tax payers
affected by top tariff but not clear cut
• Behavioural effects?

16. Conclusions
• Wide variation in redistributive effects of PIT
• Most tax exemptions & allowances enhance progressivity
• Evidence on tax deductions and credits more mixed
• Wide variety in importance of rate structure
• Zero-taxed part offers considerable contribution to
progressivity but not uniform
• Top tariffs not only drivers of progressivity

17. Comments
• Very interesting and informative paper
• Well- written & clearly structured
• How sensitive are the results to the assumptions made?
• (e.g. Assuming 100% take-up/compliance, ignoring effect of taxes paid on benefits)
• Would be good to see more on changes over time within countries
• Is this distinction between rate structure and tax base composition
countries slightly arbitrary?
• E.g. Personal allowance in UK vs. zero-rate band in Austria or Greece
• Can approach be extended to look at social insurance & other direct
taxes simultaneously?
• Compare impact on progressivity/redistribution of e.g. Increase in zero-rate
coverage vs. other tax reforms
• What do policy makers need to do (differently) as a result of this work?