Opportunities and incentives
Fiscal policies can create opportunities for those who would otherwise be disadvantaged. In many economies, advanced and emerging alike, large disparities exist between higher- and lower-income households in terms of access to quality education, health care, and digital technologies. These disparities put children in unequal starting positions.
Public spending can, in part, compensate for the gap between rich and poor in private spending on children and help reduce the importance of parental background and other circumstances that are beyond an individual’s control. This is achieved through efforts to ensure access to basic public infrastructure, such as clean water and sanitation; basic health services; and social investments—for instance, in education. These policies can increase intergenerational mobility and also, by facilitating human capital formation, can enhance long-term growth, particularly by increasing education levels among children from disadvantaged backgrounds. Public spending on basic services can be a priority where access gaps are large. However, the type of spending needs to be carefully assessed given country-specific circumstances. For instance, spending on higher education might benefit mostly richer households.
Fiscal policies can also influence inequality by providing incentives for labor market participation or children’s education. For example, labor supply and employment can be affected by labor tax wedges, the difference between a worker’s take-home pay and the corresponding total labor cost for the employer, and by participation tax rates, the difference between replacement income received by an unemployed person and his or her expected earnings. This is especially true for second earners. Refundable tax credits for low-income families, individualization of personal income tax filing, and more widely available and affordable childcare could reduce gender bias and encourage labor force participation. Conditional cash transfers, in addition to reducing poverty, can provide incentives for school attendance or regular health checkups.
Active labor market policies can support efficient functioning of labor markets, for instance through public employment services that assist the unemployed in finding suitable jobs or government-sponsored vocational training for those most excluded from the labor market. On the demand side, worker retention programs, which have been developed massively in advanced economies throughout the recent crisis, have helped governments invest in maintaining employment linkages. This has contributed to smoother recoveries and helped avoid massive job losses and business failures that would have fed inequality.
Redistribution
Redistributive policies can curb labor income inequalities. Direct taxes and transfers jointly reduce income inequality by more than one-third in advanced economies. However, in emerging market economies the extent of redistribution is much smaller. Overall redistribution accounts for 85 percent of the disposable income inequality between advanced and emerging market and developing economies. Social transfers help reduce inequality mostly at the bottom, and taxation at the top.