Balkans inequality and redistributive power of state

Balkans inequality extends to virtually all aspects of social and economic life, and is viewed by a large majority of the region’s citizens as deeply unjust. The inequality undermines the stability and legitimacy of institutions and policies, and represents a powerful drag on Balkan’s development prospects. These reasons put social equity at the top of the region’s development agenda.

A close inspection of the international evidence on income inequality reveals that the big difference between Balkans and the more egalitarian countries of Western Europe lies not so much in the extent of the inequality resulting from market forces, but in the redistributive power of the state.

To put it differently, the gap between the two regions in terms of income inequality is much bigger after taxes and public transfers than before taxes and transfers, and this implies that a good deal of Balkan’s excess inequality over international levels reflects the failure of the region’s fiscal systems to perform their redistributive functions.

And the magnitude of this failure is considerable. While in European countries direct fiscal redistribution leads to an average reduction of some 15 percentage points in the Gini coefficient of the distribution of income, in Balkans the reduction is on average about 9 percentage points.

The evidence from rich countries also shows that the bulk of the state’s redistributive impact is due to the effect of public transfers. They account for over three fourth of the overall redistributive effect.

Yet this is a conservative figure, because it ignores the regressive impact of indirect taxes, which counteracts much of the progressive effects of direct taxes, so that on the whole taxes likely achieve little or no redistribution, and the full distributive impact of the fiscal system is due to transfers.

The poorly at fiscal redistribution has three potential explanatory factors, namely: (i) too low a volume of resources gets collected and transferred; (ii) tax collection is regressive; and (iii) transfers are poorly-targeted.

All three are at play, to different extents in different countries, but on the whole the conclusion is that the prospects for significant fiscal redistribution lie mainly in increasing the volume of resources available for redistributive spending, and improving the targeting of expenditures.

In contrast, even significant increases in the progressivity of Balkan’s tax systems, which at present appear to be roughly neutral from the perspective of distribution are likely to have only a modest effect on the distribution of income.

From the perspective of inequality reduction, the overall volume of tax revenue is likely to be a more important priority than the progressivity of the revenue-raising system, a conclusion that echoes the experience of the European countries.

These considerations offer some guidance for the design of reforms to make Balkan’s fiscal systems more conducive to equity.

Such reforms will likely pose significant institutional and implementation challenges, which deserve separate analysis. But the specific reform priorities obviously vary across countries. In some countries the top priority is to expand tax collection and thereby the volume of transfers.

In all of Balkan countries, there is significant scope for raising tax collection by reducing tax concessions and loopholes, and especially improving tax administration to reduce evasion, which is rampant across the region.

Making the tax system more progressive will also help, although in general the quantitative impact on inequality is likely to be modest. This does not mean that the structure of the tax system is irrelevant, but only that tax choices should be primarily based on the efficiency and administration costs of different taxes.

For example, the taxes on financial services, now in place in a number of developed and in developing countries, may be a matter of concern in view of its distorting potential.

Budget of state has some important expenditures like social spending categories (education and health) that play a very significant role in the distribution of household income, not only in terms of the direct incidence of the expenditures across the income distribution as transfers in kind, but also indirectly, because they can help raise the human capital assets of the poor and thereby their future incomes.

Similarly, social equity is also affected by how well the state does at performing its other two classic objectives of efficiency and stabilization, because ultimately this affects the economic opportunities available to the poor and the distribution of market
incomes.

Through these indirect channels, fiscal policy can also have a major impact on Balkan’s inequality.

Regarding the stabilization objective of fiscal policy, for example, one important, contribution to social equity relates to the prevention of crises. Macro-financial crises are almost invariably highly regressive because the costs of their resolution, in the form of resource transfers to better-off investors, end up being borne by all taxpayers; furthermore, the poor often are the most adversely affected at times of crises because they lack the assets to smooth out adverse income shocks.

Excessive public indebtedness and procyclical fiscal policies have been key factors behind the region’s vulnerability to crises.

This means that fiscal prudence, possibly guided by formal fiscal rules that allow the operation of counter-cyclical policies and particularly of counter-cyclical social expenditures is also an essential part of a fiscal agenda to reduce inequality in Balkans.