Harnessing the Power of Fiscal Policy to Mitigate Inequality

Fiscal policy is a powerful and adaptable tool for achieving distributional objectives

Considering tax and spending programs together enhances the effectiveness of fiscal redistribution

Improving both distributional outcomes and economic efficiency is possible

Over the last few decades, income inequality has been on the rise in three-quarters of advanced economies and about half of the developing world, including fast-growing and densely populated countries such as China and India. This trend, together with the legacy of the global economic and financial crisis, has brought distributional issues to the forefront of the economic policy debate.

Many governments around the world now face the challenge of addressing concerns over high or rising inequality, while still promoting efficiency and growth. How can governments effectively and efficiently design redistributive fiscal policies, the book asks, especially when fiscal space is limited and concern about economic growth is also high on the policy agenda?

The analysis presented in the book builds on and extends recent IMF work, including a paper prepared for the IMF Executive Board in 2014 and a wide set of contributions on fiscal issues, such as energy subsidies, pensions, health care reform, jobs and growth, and taxation.

The book also includes contributions from leading academics. As the book highlights, inequality issues have long commanded the IMF’s attention, reflecting their relevance for macroeconomic stability and sustainable economic growth—issues at the core of the Fund’s mandate. With increased interest among policymakers, the IMF’s analytical work in this area has expanded.

Taxes and public expenditure substantially reduce income inequality

Fiscal policy, as the book shows, offers a powerful tool to achieve governments’ distributional objectives, affecting household welfare both directly (through transfers and taxes) and indirectly (by modifying incentives to work and produce). Direct taxes (that is, taxes levied on income and wealth, such as the personal income tax, in contrast to indirect taxes, which are levied on exchanges and consumption, such as sales or value-added taxes) and cash transfers (direct payments from governments to eligible individuals) are two important tools at policymakers’ disposal.

In recent decades, together they have reduced income inequality (as measured by the Gini index, a common statistical measure of a country’s income distribution) by about...