By Mikkel Hermansen, Economist, OECD Economics Department

In many advanced countries, the share of citiziens having reached post-retirement age is growing fast. Since elderly rely for a good part on a public pension scheme for income support, population ageing tends to result in more income redistribution, in particular in the form cash transfers. However, insofar as ageing also means a growing share of population in groups that are close to retirement age, but still considered as part of the working-age population, a more interesting question is how this facet of ageing affects redistribution. As we show in a recent paper on “Income redistribution through taxes and transfers across OECD countries” ageing actually tends to reduce income redistribution when the latter is measured as the reallocation of resources between people in working-age to limit the influence of redistribution across lifetime. This is primarily a result of ageing being associated with higher employment rates among seniors.

The purpose of redistribution is to reduce income inequality. Therefore it is natural to measure redistribution as the difference between the Gini coefficients of households incomes before and after personal income taxes and cash transfers.[1] This is done only for the working-age population (age 18-65)  to avoid the influence of public pensions, mostly reflecting that people pay taxes in working-age they then receive back as benefits in retirement age.

But how does ageing then affect redistribution? As Figure 1 shows, the working-age population has been ageing over the last two decades in the sense that the composition has changed towards relatively more seniors and fewer people below age 40.

Such ageing of the working-age population tends to produce two counteracting effects on redistribution. It may drive redistribution:

• upwards since seniors (age 55-64) approaching retirement are more likely to receive transfers than younger age groups and such transfers are likely to be sizeable, e.g. from early retirement, pension benefits available before age 65 or disability insurance.
• downwards since more seniors tend to work longer than in the past. Rising life expectancy has generally been associated with more years in good health, which, combined with widespread policy reforms to reduce early withdrawal from the labour market, has implied substantive increases in employment rates among seniors.

A simple empirical exercise shows that the share of seniors in total employment has risen more than the share of seniors in the working-age population in most OECD countries (Figure 2). This suggests that the employment effect has tended to dominate and ageing has thus exerted a downward pressure on redistribution in most OECD countries. We confirm this by computing the change in redistribution with and without the senior group and find for most countries a larger decline in redistribution when including seniors. Nevertheless, for most countries the impact on measured redistribution is limited and is therefore not the main factor driving the overall  decline in redistribution observed  in most OECD countries since the mid-1990s.

[1] The difference is scaled by the Gini coefficient for households incomes before taxes and transfers to account for cross-country differences in the initial level of market income inequality. See Section 3.4 in Causa and Hermansen (2017) for details.

References

Causa, O. and M. Hermansen (2017), “Income redistribution through taxes and transfers across OECD countries”, OECD Economics Department Working Papers, No. 1453, OECD Publishing, Paris, http://dx.doi.org/10.1787/bc7569c6-en.

By Orsetta Causa, Senior Economist, OECD Economics department

Tax and transfer systems are fundamental pillars of an inclusive growth policy agenda that aims at sharing the benefits of growth more equally and securing decent living standards for those in most need.  A new OECD report by Causa and Hermansen (2017) (“Income redistribution through taxes and transfers across OECD countries”) documents that redistribution through taxes and transfers has tended to decline across OECD countries since the mid-1990s. By and large, the decline in overall redistribution across OECD countries over the last decades has been primarily driven by a decline in redistribution by cash transfers. This is not surprising insofar as cash transfers account for the bulk of redistribution.

While the analysis cannot disentangle between policy and non-policy drivers of such decline in redistribution, this picture raises the concern that welfare systems are becoming less effective at ensuring income adequacy among vulnerable households. This question can be addressed by focusing on developments in market (or pre-tax and transfer) income and redistribution among households in “the bottom 40%” of the distribution. In order to isolate the effect of changes in population structure within that group, the composition of households is adjusted according to the working status of adults and the presence of children, two key parameters affecting the “need” for redistribution. This delivers the following insights, focusing on developments over the last two decades:

• Income support provided by social transfers to bottom 40% workless households has declined in the majority of countries for which data are available (Figure 1). Given the overwhelming weight of transfers relative to market income among that group, their disposable income declined markedly relative to median income. In the majority of countries for which data are available, cash transfers have become increasingly ineffective at preventing workless households from falling into relative poverty, especially in the presence of children.

• By contrast with workless households, income support provided by taxes and transfers to bottom 40% working households has increased in the majority of countries for which data are available (Figure 2). The increase in net transfer support was largely driven by declines in income taxes and social security contributions that tended to mitigate widespread declines in market incomes.

The decline in redistribution may to some extent reflect the effects of tax and transfer reforms to make work pay for individuals with low earnings potential and weak labour market attachment. Concluding from this that such reforms were inappropriate would fail to consider redistribution policies as part of broader policy packages to make growth more inclusive. For example well-designed policy packages should combine tax and transfer policies to make work pay and boost jobs with policies to improve employability, skill adaptability and wage prospects. In other words, to raise job quality for less-skilled and at-risk individuals such as disadvantaged youth and immigrants, but also for older workers facing displacement in declining sectors. The policy implication is that tax and transfer reforms should be designed within an array of complementary policy instruments to address equity and efficiency objectives, taking into account country-specific context, constraints and social preferences.

References

Causa, O. and M. Hermansen (2017), “Income redistribution through taxes and transfers across OECD countries”, OECD Economics Department Working Papers, No. 1453, OECD Publishing, Paris, http://dx.doi.org/10.1787/bc7569c6-en.

By Orsetta Causa and Mikkel Hermansen, OECD Economics department

Many OECD countries have been facing a prolonged period of low growth and stagnating income of the poorest. This challenges governments’ fiscal redistribution, all the more so in a context where new forms of work are calling into question the effectiveness of traditional social safety nets and population ageing is putting pressure on public finances. Yet, the system of taxes and transfers  that underpins social protection  is a fundamental pillar of an inclusive growth policy agenda that aims at sharing the benefits of growth more equally. A new OECD report by Causa and Hermansen (2017) (“Income redistribution through taxes and transfers across OECD countries”) takes stock of the extent to which tax and transfer systems mitigate market income inequality today, and how this has changed over a period of rising globalisation and rapid technological change.

Redistribution through taxes and transfers has tended to decline across OECD countries since the mid-1990s

Since the mid-1990s, the redistributive effect of taxes and transfers has declined in the majority of OECD countries for which data are available (Figure 1, Panel A). The trend towards less redistribution was most pronounced over the pre-crisis period, and was temporarily reversed during the first phase of the crisis, reflecting the cushioning impact of automatic stabilisers and fiscal discretionary measures. The decline in redistribution was particularly pronounced in some Nordic countries, which are among the most egalitarian OECD countries. Admittedly, the extent of the decline observed in these countries was amplified by high levels of redistribution prevailing in the mid-1990s due to high unemployment. The steadily improving labour market outlook during the subsequent decade reduced the need for redistribution. The inequality-reducing effect of redistribution also declined among the least egalitarian of OECD countries, especially Israel, but also Australia and Canada. Trends in redistribution were more heterogeneous over the most recent decade, with increases in around half of OECD countries, in particular those hardest hit by the crisis (Figure 1, Panel B).

The decline in redistribution was largely driven by insurance transfers to working-age households

By and large, the decline in redistribution across OECD countries has been primarily driven by a decline in redistribution by cash transfers, which is not surprising insofar as cash transfers account for the bulk of redistribution. Personal income taxes also contributed but played a less important and more heterogeneous role across countries (Figure 2, Panel A). In turn, the decline in transfer redistribution was largely driven by insurance transfers (e.g. unemployment insurance, work-related sickness and disability benefits). This was partly mitigated by more redistributive assistance transfers (e.g. minimum income transfers, means- or income-tested social safety net) in some countries such as Germany and the United Kingdom (Figure 2, Panel B). Assistance transfers are in many OECD countries less redistributive than insurance transfers, for instance due to low take-up but also due to relatively low benefit amounts, so that their size is generally smaller than insurance transfers.

Policy implications

One finding highlighted  in Causa and Hermansen (2017) is a fairly widespread shift in transfer policy from out-of-work to in-work support, at least partly driven by reforms to make work pay, especially for workers with weak labour market attachment. While this is likely to have mitigated market income inequalities by spurring employment growth, it could have contributed to the decline in redistribution. This should not lead to the conclusion that countries have no choice but to trade more efficiency for less equity. The reason is that redistribution policies should be considered as part of broader policy packages to make growth more inclusive. For example, well-designed inclusive growth packages should combine tax and transfer policies to make work pay and boost jobs with policies to improve employability, skill adaptability and wage prospects. To the extent that such packages have not been broadly deployed by OECD countries, potentially reflecting budgetary constraints, reductions in market income inequality induced by such reforms have not been sufficient to prevent disposable income inequality from rising.

References

Causa, O. and M. Hermansen (2017), “Income redistribution through taxes and transfers across OECD countries”, OECD Economics Department Working Papers, No. 1453, OECD Publishing, Paris, http://dx.doi.org/10.1787/bc7569c6-en.