Income Tax Progressivity: Trends and Implications
| Author | Victor Mylonas,Claudia Gerber,Li Liu,Alexander Klemm |
| Published date | 01 April 2020 |
| DOI | http://doi.org/10.1111/obes.12331 |
| Date | 01 April 2020 |
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©2019 The Department of Economics, University of Oxford and JohnWiley& Sons Ltd.
The International Monetary Fund retains copyright and all other rights in the manuscript of this article as submitted for publication.
OXFORD BULLETIN OF ECONOMICSAND STATISTICS, 82, 2 (2020) 0305–9049
doi: 10.1111/obes.12331
Income Tax Progressivity: Trends and
Implications*
Claudia Gerber, Alexander Klemm, Li Liu Victor Mylonas
International Monetary Fund, 700 19th Street NW Washington, DC 20431, USA
(e-mail: gerber.claudia@bcg.com; aklemm@imf.org; lliu@imf.org; vmylonas@imf.org)
Abstract
This paper discusses how the structure of the tax system affects its progressivity. It suggests
a measure of progressive capacity of tax systems, based on the Kakwani index, but inde-
pendent of pretax income distributions. Using this and other progressivity measures, the
paper (i) documents a decline in progressivity over the last decades and (ii) examines the
relationship between progressivity and economic growth. On this relationship, regressions
do not reveal a significant impact, suggesting that efficiency costs may be small – at least
for degrees of progressivity observed in the sample. Finally, the paper finds that increasing
tax progressivity reduces pretax inequality.
I. Introduction
Tax policy has an important role to play in addressing income inequality. At the lower
end of the income distribution – where the focus is on poverty reduction – spending
policies can also be used, and may be more important, in many countries. Even in this
case, tax policy could: (i) be used to ensure that poor individuals pay little or no tax;
(ii) mimic spending policies by offering refundable tax credits, such as tax credits related
to minimum work/some other condition (e.g. the Earned Income Tax Credit – EITC in the
United States), or through a general negative income tax (akin to a universalbasic income);
(iii) help raise revenues required for inequality-reducing spending measures.
At the upper end of the income (and wealth) distribution, especially as far as the highest
earners are concerned, there are few feasible alternatives to tax policy as a means of
redistribution: Once an individual is above the highest qualification threshold for a free or
subsidized good/service, there is no further way in which spending measures can be used
to redistribute income.
JEL Classification numbers: H23; H31.
*The views expressed in this paper are those of the authors and do not necessarily represent the views of the
IMF, its Executive Board, or the IMF management. We are grateful for comments by Ruud de Mooij, Mercedes
Garcia-Escribano, Vitor Gaspar, Catherine Pattillo, Jiri Podpieraand Abdel Senhadji, as well as FAD Seminar and
Fiscal Monitor Workshop participants and an anonymous referee. Claudia Gerber, now with the Boston Consulting
Group, worked on this paper while at the FiscalAffairs Department.
366 Bulletin
The main way tax policy can reduce income inequality is through progressive income
taxation, i.e. designing a tax system so that the average tax rate rises with income. There
are two main aspects to this:
•First, the structure of the tax system determines by how much average tax rates rise.
The simplest progressive tax system would be a flat tax rate combined with a per-
sonal allowance, but more complex systems with multiple rates can achieve greater
progressivity.
•Second, the taxation of different sources of income plays an important role in deter-
mining the overall progressivity of the tax system. In many countries, capital income is
taxed at lowerrates than labour income. This affects the overall progressivityof the sys-
tem, especially in the typical case in which capital is distributed even more unequally
than wages.
One of the first obstacles to overcome in studying the progressivity of tax systems
relates to its measurement. While many measures have been proposed, they each have
their pros and cons. Notably, since the progressivity of most tax systems differs widely
across incomes, many measures are very sensitive to the chosen income at which they
are obtained. Hence, rankings of countries in terms of progressivity depend strongly on
whether one looks at how progressive systems are for median wage earners or individuals
with much lower or higher incomes. Other measures depend stronglyon the pretax income
distribution. Even very progressive tax systems will not redistribute much if the pretax
distribution is already very even. Many measures are based on actual redistribution and
would, therefore, identify such systems as lacking progressivity – even with average tax
rates that rise very steeply.This paper suggests a different approach for the quantification of
progressivity, which is independent of the pretax income distribution. Both this approach
and other available measures confirm the suspicion that progressivityhas declined over the
last decades.
This decline in progressivity raises the questions of (i) why it occurred and (ii) whether
it has benefited growth. Klemm, Liu, Mylonas, and Wingender (2018) examine potential
explanations within the framework of optimal tax theory, by exploring whether any of the
standard components of optimal top tax rates may explain the decline in progressivity.
These are (i) the sensitivity of income to tax rates, (ii) the share of income earned by
those on the highest incomes, and (iii) the welfare weight placed on those with the highest
incomes. They cannot find such evidence and conclude that other reasons, possibly related
to political economy considerations, are likely behind the progressivity decline.
There is a large literature showing how competition of parties for voters can lead
to complex tax structures, with more flexible voters having more influence (e.g. Wars-
kett, Winer and Hettich (1998)). Empirically, too, there is evidence that political factors
may be more important than economic ones in explaining tax reforms (e.g. for labour
taxes, Castanheira, Nicod`eme and Profeta (2012)). There are also papers showing the-
oretical models (e.g. Rodriguez (2004)) or empirical evidence (e.g. Ardanaz and Scar-
tascini (2011)) supporting the idea that better-off individuals might have more political
influence.
The impact of progressivity on growth is considered in this paper. A positive effect
of declining progressivity on growth would not in itself prove that such decline is
©2019 The Department of Economics, University of Oxford and JohnWiley& Sons Ltd.
The International Monetary Fund retains copyright and all other rights in the manuscript of this article as submitted for publication.
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