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Missed target: IMF policy paper on fiscal policy and inequality

by Peter Bakvis

Missed target: IMF policy paper on fiscal policy and inequality

 

An “IMF Policy Paper: Fiscal Policy and Income Inequality” was launched Thursday at the Peterson Institute think-tank in Washington by the Fund’s second-in-command, David Lipton.

The IMF has issued several research papers on the theme of inequality in recent years, but this is the first that has the status of a “Policy Paper”, meaning that it was discussed by the board of directors before finalisation and publication.

The IMF is certainly not the first international institution to issue reports on inequality, and this one both lacks scope in analysing the causes of growing inequality and is very guarded in its policy proposals.

It should no doubt be seen as a step forward that the IMF acknowledges the problem of inequality in a policy report, but the Fund will have to do further work if it is to develop serious and actionable policy proposals against inequality in most of the areas where it has influence.

The policy paper summarises the causes of growing income and wealth inequality in one sentence (page 4), ignoring such factors as financial deregulation and weakening of labour market institutions.

Since it was prepared by the IMF’s fiscal affairs department, it not surprisingly focuses on redistributive fiscal policies rather than addressing any underlying causes of inequality.

However in a few lines on “other policy instruments” (than fiscal ones), it breezily dismisses employment protection regulations and particularly increased minimum wages because they are “a blunt instrument for addressing inequality, since … benefits will also accrue to non-poor households with members working at low wages” (p 24).

The authors seem to have forgotten that they were writing a report on reducing inequality, not just reducing poverty.

 

From child benefits to unemployment benefits

The same could be said of almost all of the recommendations made in the paper for public expenditures, where the emphasis is on means-testing, targeting and selectivity to ensure there is no leakage of benefits to non-poor.

Thus, in advanced economies the paper recommends that child benefits should be means-tested and parental leave benefits reduced (p 28). It favours intensifying use of active labour market programmes (ALMPs), but only if there is “strict conditioning of eligibility on participation in ALMPs” (p 29).

In line with IMF practice in several of its lending programmes, the paper recommends increasing the retirement age in advanced economies, though it acknowledges that this could actually make pensions less redistributive “because lower-income groups tend to have shorter life expectancy” (p 26).

This problematic effect “may require strengthening of labor regulations protecting older workers”, which is an interesting conclusion given the papers’ rejection of employment protection regulations two pages earlier.

For developing countries, it favours “social pensions” and conditional cash transfers as long as they use means testing or “tagging” (proxy means tests), even though the report acknowledges that means testing is beyond the administrative capacity of most low-income countries (p 32).

The paper’s approach to unemployment benefits is that they are acceptable as long as they are “designed to strengthen incentives to take up employment”. The key attributes it recommends for jobless benefit schemes are “strict eligibility criteria”, “short duration” and “declining benefit levels” (p 33).

The paper emphasises improved access to education and health care for low-income households in developing countries, which may be logical in view of their lack of access to those services in much of the developing world, but it applies the same logic to advanced economies.

It thus includes a recommendation that rich countries should “maintain access of low-income groups to essential health services” (p 43), which sounds like considerably less than the status quo since almost all developed countries offer universal healthcare.

The IMF inequality paper’s emphasis on targeting and means-testing is troublesome. As one commentator at the launch of the paper on Thursday remarked, countries that have been the most successful in reducing inequality did so through universal, not means-tested programmes.

There is an economic reason for this – means-testing is burdensome and costly and inevitably many lower-income households are denied access – but also a political one: middle classes may be reluctant to finance through their taxes programmes from which they never benefit.

 

Taxation – advanced but hardly groundbreaking

The Fund’s inequality policy paper is slightly more advanced on the taxation side, but hardly ground-breaking. It notes the reduction of top personal income tax rates over the past 30 years and supports progressive rate structures.

However it shies away from recommending any generalisation of more income tax progressivity by focusing on the situation of the 27 countries, mostly in Central and Eastern Europe and Central Asia, that have adopted flat-tax regimes, stating that “there may be scope for more tax progression at the top” (p 37).

The paper rightly notes that some tax deductions, notably mortgage interest deductions, “accrue disproportionately to the rich” and it favours “rationalizing” them (p 38).

However it takes a cautious approach regarding the taxation of capital income at lesser rates than labour income. The report warns of the “mobility of capital” and states that high taxes on capital gains and dividends “can have high efficiency costs because of their distortionary effects on saving and investments” (p 38-39).

The paper observes that wealth taxes of various kinds, including those on immovable property, have fallen far behind the surge in global wealth, and have also declined as a proportion of average GDP.

It agrees there is scope for increased property taxes but downplays net wealth taxes because they “raise little revenue [and] are easily evaded”, though it acknowledges that increased international cooperation could make them more effective.

On the subject of financial transactions taxes, it asserts that “their distributional impact is unclear” (p. 41).

The report agrees that value added taxes are generally regressive but argues against exemptions or reduced rates on necessities, because like minimum wages, “they are blunt redistributive instruments” (p 41).

It prefers using proceeds from a single-rate VAT for social benefits. The paper also opposes excise taxes on luxury goods because they raise little revenue and have high administrative costs.

Overall, with a few exceptions the IMF’s policy paper evokes a host of administrative and efficiency grounds to object to a substantial overhaul of tax systems to make them more progressive and contribute to a reduction of inequality.

Conversely, the paper downplays the administrative costs and political viability of its strong emphasis on targeting and means-testing to limit access to many public expenditures to the poor. It makes no attempt to evaluate the overall impact on inequality of cutting off lower-income households that are above the poverty threshold from such services.

The paper does not deal with actions in which the IMF is involved, such as weakening of collective bargaining structures in several countries, which will inevitably worsen inequality going forward.

And it has nothing to say about the role of financialization, where the Fund could play a much stronger role in proposing more robust regulation of the financial sector.

One may welcome the support expressed in the paper for the action plan against profit shifting and base erosion by multinational enterprises to reduce their global tax liabilities, as well as for the international information exchange to prevent tax evasion.

But the report is mute on what the IMF, with its almost universal membership and oversight of countries’ financial and economic affairs, intends to do to ensure implementation of these instruments.

 

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