Tax and social programs and economic inequality

In countries with economies in transition, inequality has typically increased. In Central and Eastern Europe, inequality has grown at a gradual and steady rate on average, whereas in the South East Europe inequality initially increased sharply, peaked in the last decade and, since this time, actually there’s a trend to grown very fast.

After the initial economic crisis brought on by transition, many states were able to stimulate growth and some, employment; despite these successes, slow or non-existent employment growth and high unemployment continue to be problems in the region.

In the region countries, not only is the tax base narrow, but the bulk of employment is in the informal sector, while social transfers are very limited. The Balkan countries have tried to managed to reduce inequality through tax and transfer programs, but has generally not been able to reverse this raising trend. One of the reasons is that the re-distributive role of tax is negligible, because tax revenue is dominated by indirect taxes (such as consumption taxes), which are regressive.

Generally speaking, indirect taxes have become a more important source of government revenue. And that’s a problem for the policy of reduction of poverty and inequality. By contrast, tax rates both on corporate income and on top personal incomes have, on average, declined over the past 15 years or so. But, since the tax base is not very broad and the taxes on capital by the politicians are declared that will be part of more decline, than this is not good news and policy for the people that work hard and earn little.

Another factor is that the weaker progressivity of tax systems has not been offset by increased recourse to social transfers for redistribution. Although targeted social assistance is much more progressive than other social transfers, especially in developing countries, the budget allocated to assistance is too small to make any significant difference in inequality. On the other side, spending on social insurance programmes has grown relatively quickly, but often with little effect on reducing income inequality. Indeed, such programmes tend to be only slightly progressive or actually regressive, since they exclude informal sector workers.

While social transfers have the potential of reducing inequality, progressive programmes (such as universal pension schemes, social assistance) are underfunded and regressive transfer schemes are dominant. In addition, social expenditure is not always progressive. While health spending has been found to be progressive, though education spending at the primary and secondary levels was generally progressive.

Although income tax policy today tends to make the after-tax distribution of net worth less concentrated than the pre-tax distribution, the effectiveness of the tax system in reducing inequality has decreased over time.

There may be efforts for increasing the progressivity of the tax system. To this end, governments could ensure that tax rates on high incomes are not further reduced, but the most important for the countries like Albania or Kosovo there’s need more efforts about administration of this type of tax.

Tax and social policy need to support employment a key redistribution mechanism. This means removing tax distortions that affect labour market participation.

Social policy can be used more actively without sacrificing growth or employment objectives. Access to basic social services, such as education, health and water, should be universal as these services increase human capital, support economic growth and limit the risk of excessive income inequality.