Are Tax Expenditures a Good Way to Redistribute?

Since 2007, governments across several European countries have implemented cuts to their social programs in an attempt to tackle the fiscal deficits generated by the last economic and financial crisis. At the same time, they have increasingly made use of various tax related measures to achieve implicit or explicit redistributive purposes. For example, the UK government has implemented some of the most drastic welfare cuts while almost doubling the amount of income exempt from personal income tax. Similarly, France recently increased its zero rate tax band, Italy launched a new refundable tax credit for employees, and Germany increased significantly a number of its existing tax reliefs. In 2015, at least eight other countries have taken measures to decrease their tax base which can be thought of as partly having a social purpose.

It may be that redistribution through the tax system can have several advantages such as decreased administrative costs, lower stigma and application costs or/and increased political acceptability. However, are tax expenditures well placed to channel resources towards the poor? The current consensus is that tax expenditures are a large fiscal item that is subject to much less scrutiny than comparable spending programs. There is also evidence showing that many tax exemptions and deductions aimed at incentivising behaviours (such as for example, tax deductions for expenditure on energy saving and insulation) tend to benefit upper and middle income groups rather than the poor. Less is known about the way tax expenditures that have a clear social goal affect the income distribution.

In a paper examining tax expenditures in six European countries in 2010, I used microsimulation techniques combined with household micro-data to investigate the prevalence and distributional effects of legal provisions that lower taxable income (tax allowances) or the final tax liability (tax credits) for specific groups of personal income tax payers. I showed that both tax allowances and tax credits were pervasive in the countries that used them, reaching large sections of the populations not just the well-off. However, with the exception of Denmark, those in the bottom 20% of the income distribution were much less likely to receive these tax advantages compared to the rest of the population. Furthermore, the value of these tax advantages tended to rise with income meaning that their effect was generally to increase inequality.

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