Sound Policy Design: the Efficient Way to Cut Inequality

Inequality growing across many regions in the world

Fiscal policies can help countries reduce inequality

Redistributive policies should be designed with efficiency in mind

Growing inequality in recent years has put increased pressure on fiscal policy to redistribute income. While the question of just how much redistribution the state should do, in the end, rests with national governments, the design of the policies themselves has a critical bearing on their effects on efficiency and growth.

The design of these growth-friendly, efficient redistributive fiscal policies is addressed in a new IMF staff paper on fiscal policy and income inequality. This study is just the latest look by IMF staff at how inequality affects growth. A paper by IMF research staff released last month also examined this connection.

Assessing the effect of tax and spending policies on efficiency, along with how they affect distributional goals, has long been a component of the IMF’s policy advice to member countries in the context of its technical assistance. In IMF lending programs, a common concern is how to design fiscal policy measures in a way that is consistent with the authorities’ distributional objectives. The paper brings together the extensive experience of the IMF across these areas.

“When it comes to fiscal redistribution, design matters,” said IMF First Deputy Managing Director David Lipton. “Redistribution, if poorly designed, or pushed too far, can be distortive,” he said, “but some redistributive fiscal policies can in fact help improve efficiency and support growth, such as those that enhance the human capital of low-income households.

Trends in inequality

Over the last three decades, inequality has increased in most countries. While the level of inequality has declined in Latin America and sub-Saharan Africa recently, what is striking are the persistent differences across regions, with Latin America still having the highest inequality and the advanced economies having the lowest.

More recently, there has been attention to the rising share of top income earners. The paper suggests that the trends across countries appear mixed. In some economies, such as the United States and South Africa, the share of the top one percent has increased dramatically in recent decades, but not so in continental Europe and Japan, where it has been largely unchanged. There are differing views of the causes of the rising share of the top one percent. Some emphasize the...