Income redistribution through taxation – how deductions undermine the effect of taxes

Abstract

This paper shows the potential of administrative data to grant us a more complete picture of the redistributive effects of the visible (tax rates) and hidden (tax deductions) instruments of the fiscal welfare state. Based on administrative tax data from a large Swiss canton, we apply a gini-based redistributive effect decomposition to demonstrate how several taxes and deductions impact the post-tax income distribution. We show that tax deductions drastically reduce the redistributive effect of taxes because lump sum deductions in a progressive tax system lead to greater tax relief for higher income earners. Moreover, high income earners have additional options to claim deductions such as real-estate expenses or extra-mandatory payments to the pension scheme. Comparison over time furthermore shows that the role of deductions for real-estate expenses decreased. All in all, because deductions reduce the redistributive effect of taxes, they lead to higher post tax income inequality compared to a hypothetical system without deducations. The redistrubtive effect of the tax system should therefore be studied, not only with respect to tax rates, but also with respect to deductions.

The Effect of Property Tax on Income Redistribution in Selected African Countries

“…This article discovered that an increase in tax revenue increased income distribution in developing countries. Similarly, Hümbelin and Farys [12] investigated income redistribution through taxation in Switzerland. The article discussed specifically how a reduction in tax affects income redistribution.…”

Progressivity and Inequality

“…Incomes derived from assets may present valuation problems that can appear to introduce an element of randomness into the relationship between pre-intervention and post-intervention income. The effect of deductions may undermine progressivity [23] and the complexity of the jurisdiction's tax structure may result in unequal knowledge by income recipients of legitimate opportunities to reduce tax liability. Different tax-benefit schedules will be applied to specific population groups with different needs, but the differences in the taxbenefit schedules are unlikely to conform with the adjustments that might be made when designing an equivalence scale on social-welfare grounds [24].…”

The removal of tax expenditures from Spanish personal income tax: Impact on tax collection and income distribution

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