Appendix I. Who Benefits from Tax Incentives for Charitable Giving?

Many advanced countries provide tax incentives for charitable giving as a way to increase private funding of organizations dealing with education, science, culture, environment, religion or other forms of philanthropy. Donations are either deductible for income tax (Australia, Belgium, Denmark, Germany, Greece, Japan, the Netherlands, Norway, Switzerland, United Kingdom, and United States) or enjoy a tax credit that is granted at a fixed rate (Canada (29 percent), France (6), Ireland (31), Italy (19), New Zealand (33⅓), Portugal (25), and Spain (25)). In the United States, total donations in 2010 were US$291 billion—1.9 percent of GDP—with three quarters coming from individuals and the rest from firms and foundations. Elsewhere, donations are usually smaller (Charities Aid Foundation, 2006).

Tax subsidies for charitable giving can reduce inequality, although not necessarily. One needs to distinguish different effects. First, the tax-subsidy itself generally increases with an individual’s income, both because the rich donate more and because they take their tax deductions against a higher marginal tax rate. This renders the tax subsidy regressive, as the rich enjoy more benefit per dollar spent. However, one might alternatively argue that the mere transfer of funds by a rich donor reduces the donor’s ability-to-pay and therefore reduces the inequality of private consumption. The redistributive impact of the tax-subsidy therefore depends on how one views the character of the transfer. A second issue is that spending by charitable organizations can have various redistributive effects. Spending on higher education and arts, for instance, is less redistributive than spending on organizations that support the basic needs of the poor. In the United States, top income earners donate primarily to higher education and arts, while middle-income groups give to other charities (Colinvaux, Galle, and Steuerle, 2012). Hence, the tax subsidies for the highest incomes might ultimately be less redistributive than those for middle incomes. Finally, public support may crowd out private charitable giving. If so, the government might more effectively encourage redistributive charitable giving through tax subsidies than by providing redistributive support itself. Crowding-out is generally found to be limited, however, with some studies putting it in the order of 20 percent (Schiff, 1985).

The effectiveness of tax deductions depends on the price elasticity of charitable giving, i.e., the response to the net-of-tax price of the donation. If this elasticity exceeds one, the subsidy will boost donations by more than it reduces government revenue. This ensures that total support to the charitable organizations increases, even if the government were to withdraw its funding by the same amount. If the price elasticity is smaller than one, however, total support might decline as compared to direct government spending. There is great controversy in the literature as to whether the elasticity exceeds one. Most studies find that it does, although more recent work suggests it might be smaller than one (Fack and Landais, 2011).

Appendix II. Recent Fiscal Consolidations and Income Inequality

The extent and composition of recent fiscal consolidation packages implemented in nine European countries since the global financial crisis differ substantially across economies. The impact of fiscal consolidation on overall disposable income ranged from 1 percent to more than 11 percent, contributing to reductions in living standards of the population. The adopted fiscal measures varied across countries (Appendix Figure 1). Public sector pay reductions were significant in Greece, Latvia, Portugal, Romania, and Spain. Public pension cuts or a freeze in benefits were prevalent in Romania, Portugal, and to a lesser extent, in Spain. Changes in pension indexation were adopted in Estonia. Reductions in means-tested benefits were large in Portugal and the United Kingdom, while reductions in untargeted benefits were sizeable in Lithuania and Latvia. Income tax hikes played a major role in Greece (with an important base-broadening component) and Spain, and increases in worker social insurance contributions played a role in Latvia and Estonia. Increases in VAT rates were adopted in all nine countries.

Appendix Figure 1.
Appendix Figure 1.

Aggregate Effect and Composition of Simulated Fiscal Consolidation Measures, 2008–12

(Percent of total household disposable income)

Citation: Policy Papers 2014, 040; 10.5089/9781498343671.007.A999

Source: Avram and others (2013).Note: The aggregate impact of VAT is calculated as the unweighted average of the percentage impact across household disposable income quantiles, and is likely to overestimate the aggregate impact.

The overall distributional outcome reflects the composition and design of the consolidation package. Micro-simulation studies indicate that these fiscal adjustments relied on progressive measures. These studies focus exclusively on the impact of spending and tax consolidation measures on household disposable income and consumption, and do not assess the impact of these measures on market income (Callan and others, 2012; Avram and others, 2013; Koutsampelas and Polycarpu, 2013). For a subset of nine countries, studies simulate the impact on disposable income of specific consolidation measures adopted during the period 2008–12 (Appendix Figure 2).

Appendix Figure 2.
Appendix Figure 2.

Change in Household Disposable Income by Type of Measure and Income Group, 2007–12

(Percentage)

Citation: Policy Papers 2014, 040; 10.5089/9781498343671.007.A999

Source: Avram and others (2013).

The results suggest that:

  • The overall progressivity of the consolidation package in Greece has been driven by progressive public sector pay cuts, pension cuts, and income taxation. Public sector wages were capped, special allowances for civil servants reduced, and the 13th and 14th salaries abolished for high earning workers. The poorest 10 percent of the population were hit relatively harder by the reform of the income tax, which reduced the tax-free threshold from EUR 12,000 to EUR 5,000 in 2011.

  • The progressive incidence in Spain was also due to public sector pay cuts and changes in income taxation, although the poorest 10 percent of households were relatively harder hit by the 5 percentage point cumulative VAT increases imposed over 2010 and 2012. The public sector pay cut averaged 5 percent but increased with wage up to 9.7 percent, and was followed by a freeze and the elimination of the 14th month of pay.

  • Moderately progressive public sector wage and pension cuts also drove the overall mildly progressive effect of consolidation in Italy, although the scale of the household average income loss was very limited due to a narrow targeting of the implemented measures, which by design only affected a small part of the population. Public sector wages above EUR 90,000 and EUR 150,000 per year were cut by 5 and 10 percent respectively.

  • In Portugal, the overall progressive incidence was due to progressive cuts in public wages and pensions, which offset the regressive cuts in means-tested social transfers which negatively affected households in the bottom decile. Public sector pay cuts increased with wage to a maximum of 10 percent, and included the suspension of the 13th and 14th months of pay in 2012. Benefit reductions included a decrease of the amount and tightening of the eligibility conditions for family benefits. The suspension of the 13th and 14th months of pay was reversed in 2013 (after the period under consideration in the analysis).

  • The moderately regressive path observed in Lithuania was the result of slightly progressive public sector pay cuts—involving basic wage rates, coefficients, and bonuses—and cuts to untargeted benefits.

  • In Romania, the overall incidence was progressive due to public sector pay cuts, real pension reductions for middle-class and rich pensioners, and means-tested benefits.

  • Progressive reductions in public sector pay, which decreased the average wage by about 10.5 percent, and non-pension benefits more than offset regressive cuts in public pensions and drove the overall progressivity in Latvia.

  • The overall regressive effect observed in Estonia, on the other hand, was driven by a change in the indexation of public pensions, although means-tested social assistance lessened the impact on the incomes of the poorest.

  • In the United Kingdom, the overall incidence was progressive, due to higher taxes, especially on the richest 1 percent of the population.

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1

In this paper, the category “developing economies” covers both emerging and low-income economies. These are merged together because they face similar issues, and data availability for both groups of economies is similar.

2

Rajan (2010) argues that rising inequality led to political pressure for more housing credit, which distorted lending in the financial sector. Kumhof and Rancière (2010) show that in the United States, the Great Depression starting in 1929 and the Great Recession starting in 2007 were both preceded by a sharp increase in income and wealth inequality and by a rapid rise in debt-to-income ratios among lower- and middle-income households.

3

Other tools to influence income distribution include labor market, product market, and institutional reforms, as well as asset redistribution. These can have an influence on inequality directly or through their effects on growth.

5

The paper has also benefited from consultation with Civil Society Organizations and labor unions on its principal conclusions and policy recommendations. In their comments, they emphasized the limited capacity of developing economies to target social spending and protect the poor from spending cuts; the need to protect low-income workers, who may have short life expectancies, during pension reforms that raise retirement ages; the need to strengthen information sharing on corporate taxation; and concerns that value added taxes, in practice, were regressive.

6

Data on the inequality of market incomes is much more limited, being available mostly for advanced economies and for a shorter time period. For country specific data on Ginis for disposable income, see Bastagli, Coady, and Gupta (2012). For a discussion of the issues that arise when comparing income inequality measures across countries and time, see Atkinson and Bourguignon (2000), Atkinson and Brandolini (2001), and Deaton and Zaidi (2002).

7

The Gini is less sensitive to inequality at the extremes of the income distribution than many other commonly used measures. However, other inequality measures show a similar trend in overall income inequality. For instance, the ratio of the income share of the top 20 percent of the income distribution to the share of the bottom 20 percent has a correlation coefficient with the Gini of around 0.85.

8

More recent data for a sample of only advanced countries suggest a similar conclusion; see, for example, IMF (2013b).

9

Administrative data, however, points to a lower share of non-financial wealth. For instance, Eyraud (2013) reports that financial wealth is between 60 and 70 percent of total gross wealth in Japan, Switzerland, and the United States. Survey data for these countries suggest a share that is well below 50 percent.

10

The study cited here on mobility (Corak, 2013) focused on the relationship between a father’s and son’s incomes. A lower value for the elasticity suggests more mobility, that is, a weaker relationship between a father’s income and a son’s income.

11

Chetty and others (2013) also finds that intergenerational income mobility varies substantially throughout the United States, being especially low in southern states.

12

For critiques of these standard approaches to incidence analysis, see Kotlikoff and Summers (1987) and Boadway and Keen (1993). Whalley (1984) shows how apparently plausible changes in incidence assumptions can have a large effect on the estimated distributional impact of the tax system. Dilnot, Kay, and Keen (1990) provide an alternative rationalization of standard incidence studies in terms of “wedges” between what individuals take from and contribute to the wider economy.

13

Although public sector support for access to finance (e.g., mortgage, finance, and education loans) can also affect inequality, this impact is not included in these studies. Correcting market failures that strengthen access to finance can also reduce the inequality of lifetime income and of opportunity.

14

Paulus and others (2009) also find that fiscal policy decreases the poverty rate in 19 OECD countries from an average of 30 percent to 15 percent, with virtually all of this being achieved on the transfer side of the budget.

15

For example, some countries with high poverty rates may prioritize decreasing poverty rather than inequality.

16

For example, in a minimum income scheme where the transfer equals the difference between an individual’s income from work and the poverty line, the implicit marginal tax rate on work is 100 percent. In this case, a more gradual phasing out of the benefit as labor income rise would reduce these disincentives to work, although fiscal savings from means-testing would be lower.

17

For example, linking benefits to age (e.g., as with child benefits, education grants, and pensions) or geographic location (as with housing costs) may be an effective way of targeting benefits to lower-income groups.

18

See OECD (2012) for further discussion.

19

CBO (2014), for example, indicates that 19 percent of the benefits from raising the minimum wage in the United States would accrue to families below the poverty line, and 29 percent to families with incomes three times the poverty line.

20

In the United States, it has been estimated that 70 cents per dollar spent on the earned income tax credit ultimately benefits employers by reducing their labor costs (Rothstein, 2010).

21

In most countries, pensions contributions are exempt from income taxation while pension benefits receive favorable tax treatment, e.g., with special deductions or income tax schedules based on age (IMF, 2013b). Only 10 advanced and emerging economies (Austria, China, Chile, Denmark, France, Iceland, New Zealand, Poland, Russia, and Sweden) treat pensions like any other form of income, and some (notably, several emerging economies) fully exempt pension income from taxation.

22

For instance, Moller (2012) shows that treating pensions like other forms of income in Colombia would reduce the Gini coefficient by 0.20 of a percentage point.

23

For example, spending on social pensions exceeds ½ percent of GDP in a number of Latin American countries (Bolivia, Brazil, Chile, Guyana, and Uruguay). South Africa’s Social Grants Program includes a means-tested social pension program costing 1.3 percent of GDP.

24

Based on a pension set at 70 percent of country-specific poverty lines, Kakwani and Subbarao (2005) estimate the cost of a universal pension for everyone over 65 years of age in 15 sub-Saharan African countries to range from 0.7 percent of GDP in Madagascar to 2.4 percent of GDP in Ethiopia. Limiting the pension to only the elderly poor would approximately halve this cost for most countries.

25

Active labor market programs can also help decrease income inequality by increasing the wage received by workers when they return to the labor market (e.g., through training and better job matching). The administrative capacity required to implement these programs means that they are suitable mainly for advanced and a few emerging economies; the low level of social benefits in low-income economies means that disincentive issues are typically much less important.

26

Virtually all of the disincentives for labor market participation inherent in the tax-benefit system arise from the withdrawal of means-tested benefits (OECD, 2011a). In a study of European economies, Immervoll and others (2007) find that transferring an additional euro from high- to low-income individuals through traditional means-tested transfer programs results in a reduction in the welfare of high-income individuals by EUR 2 to EUR 4 in most economies.

27

A meta-analysis by Card, Kluve, and Weber (2010) finds that job search assistance programs are most effective at decreasing unemployment over the short term while classroom and on-the-job training are effective in decreasing unemployment over the medium term.

28

Spending on social assistance is especially low in low-income countries in the Asia and Pacific region and in sub-Saharan Africa (see Figure 8).

29

Staff estimates based on benefit incidence data from the World Bank ASPIRE database and data on current levels of social assistance spending in emerging and low-income economies. The median share of social assistance transfers accruing to the bottom 40 percent of the income distribution is 46 percent, while the median level of social assistance spending was 0.76 of a percent of GDP. Eliminating all leakage of benefits to the top 60 percent of the income distribution (i.e., 54 percent of total spending) would therefore reduce spending by 0.41 percent of GDP.

30

Staff estimates based on World Bank ASPIRE database. The scale factor is calculated as [1+(1-B)/B] where B is the share of benefits accruing to the bottom 40 percent of the income distribution. The estimates implicitly assume that all beneficiaries receive the same benefit level.

31

Post-tax subsidies are also substantial in advanced economies. Of the global total of U$2.0 trillion in 2011, advanced economies account for about a third (Clements and others, 2013).

32

In Mexico, for instance, the CCT program was financed by eliminating food subsidies. Coady and Harris (2004) estimate that, in addition to the gains from better targeting, the elimination of price subsides generated substantial efficiency gains equivalent to MEX$38 for MEX$100 pesos spent on the program.

33

Reflecting high levels of informality and weaker administrative systems, few developing economies have unemployment insurance or assistance programs and, where they exist, they often have very low levels of coverage (Robalino, Rawlings, and Walker, 2012).

34

Such reforms have contributed to a substantial decline in unemployment in Germany. Over the past decade, Germany has implemented wide-ranging labor market reforms, including improving job search efficiency, raising work incentives, and fostering labor demand (Jacobi and Kluve, 2006; Hüfner and Klein, 2012).

35

Maximum duration is often increased temporarily during prolonged recessions; these temporary measures are not included in the duration numbers.

36

See OECD (2010), Hanushek and Woessmann (2011), and Pritchett (2013) for more detailed discussion.

37

See IMF (2011) for a more detailed account of options for revenue mobilization in developing economies.

38

The PIT generally raises between 1 and 3 percent of GDP in developing economies compared to between 9 and 11 percent of GDP in advanced economies, In the former group, less than 5 percent of the population pays PIT and less than 15 percent of the income is reached by it. In some developing countries, however, the PIT raises more than 5 percent of GDP, such as in Georgia, Malawi, Namibia, Papua New Guinea, South Africa, and Swaziland.

39

Many flat tax reforms since the 1990s have come along with an increase in the exemption threshold. Together with a lower top PIT rate, this caused a shift in the tax burden from the (very) low and (very) high incomes towards the middle (Keen and others, 2008).

40

In the OECD, the top PIT bracket starts at more than five times the average wage in Chile, Germany, Greece, Portugal, and the United States, but at less than 1.5 times that in Belgium, Denmark, Luxembourg, and the Netherlands (Torres, Mellbye, and Brys, 2012).

41

Some economies also have thresholds for the payment of social security contributions. While adding to the progression of the tax system, this can undermine the benefit principle that underlies social security systems.

42

With a tax deduction (D), tax due is t (Y-D), where Y is income and t the tax rate. With a tax credit (C), tax due is tY -C. Hence, the difference is that the value of a deduction depends on the marginal tax rate faced by the taxpayer, whereas the value of a tax credit is the same for all taxpayers.

43

Some studies, however, find that taxes on capital are efficient, see e.g., Golosov, Kocherlakota, and Tsyvinsky (2003). For an overview of the efficiency argument for positive capital income taxes, see Jacobs (2013).

44

Some economies adopt imputation systems to mitigate double taxation of dividends. However, many have abolished these systems over the past decades due to international complications and, in Europe, due to rulings by the Court of Justice.

45

Outside of the advanced economies, Colombia, Namibia, Russia, South Africa, and Uruguay collect more than 1 percent of GDP through recurrent property taxes.

46

Recurrent taxes on net wealth are different from levies that are one-off. The latter come along with significant risks of economic distortions and have almost never been successful at raising revenue (Eichengreen, 1989). See also the IMF blog “Once and for all—Why capital levies are not the answer,” http://blog-imfdirect.imf.org.

47

The regressivity of excises on cigarettes is smaller, however, when consumers of cigarettes have time-inconsistent behavior. Excises will then correct for the lack of self-control, yielding private benefits to consumers, which mitigates the regressive impact of the tax (Gruber and Koszegi, 2001).

48

If fiscal consolidation is postponed and macroeconomic imbalances are not addressed, there may still be a reduction in growth and unemployment.

49

This effect can operate through the labor market as the number of long-term unemployed rises and individuals lose human capital.

50

Appendix II discusses specifics of the measures and simulation results in the nine economies. Results for Ireland and Cyprus are also available but only capture the aggregate effect of fiscal measures on inequality, and exclude the effect of VAT increases. The results for Ireland indicate that the aggregate effect of tax and social benefit measures, as well as reductions in the public wage bill, was to decrease the incomes of the bottom 10 percent by about 5 percent, and of the top 10 percent by about 13 percent during 2009–12 (Callan and others, 2012). Results for Cyprus indicate that tax and payroll contribution increases implemented in 2012 reduced the incomes of households in the bottom 20 percent by 0.1 percent and those of the top 20 percent by 2 percent (Koutsampelas and Polycarpou, 2013).

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Successful fiscal adjustments are also beneficial over the longer term by reducing public debt ratios and creating the fiscal space for countercyclical policy responses to external shocks. This can help dampen the effects of these shocks on unemployment.

Fiscal Policy and Income Inequality