Four profiles of inequality and tax redistribution in Europe

The paper begins by highlighting the significant rise in income inequality across most Western countries in recent decades, citing the OECD's 2008 report *Growing Unequal* as a pivotal moment in raising political and academic awareness. The widening gap between the richest 10% and the bottom 10% is illustrated, emphasizing the disparity revealed by both survey and fiscal data. The paper emphasizes the multifaceted negative impacts of economic inequality on social mobility, financial stability, and subjective well-being, framing the issue as both a normative problem and a social, economic, and political risk. The study focuses specifically on income inequality within European countries and examines the redistributive effects of personal taxation on income inequality.

The paper reviews existing literature explaining the upward trend in income inequality. It discusses the role of technological advancements and skill-biased technological change, which increases the productivity gap between skilled and unskilled workers, leading to wage inequality. The influence of globalization in exacerbating this inequality by enabling the outsourcing of routine tasks to low-wage countries is also considered. The impact of institutional changes, such as declining union density and collective bargaining, which contribute to reduced wage compression and increased wage inequality, is discussed. The paper also references Piketty's *r > g* formula, which highlights the widening gap between the rate of return on capital and economic growth as a driver of wealth and income inequality, and Atkinson's observation regarding the declining wage share in Western countries since the 1970s.

The analysis relies on data from the European Union Statistics on Income and Living Conditions (EU-SILC), a multidimensional microdata source on income, poverty, and living conditions. While the data is collected at the individual level, the unit of analysis is the household, with income equivalized using the OECD-modified scale to account for household size and composition. Gross income includes wages, self-employment income, pensions, and social transfers. Adjusted gross income adds interfamily transfers paid to analyze gross income without non-tax deductions. Tax redistribution is measured using a variable that considers personal income tax and social security contributions. The study acknowledges limitations of survey data like EU-SILC when focusing on restricted top quantiles (top 1%), noting that sample sizes and underrepresentation of the very top income earners can affect accuracy. Thus, the analysis focuses on broader top quantiles, such as the top decile and ventile. Data from approximately half the countries covered refers to 2014, while the remainder is from 2013. Three measures are used to assess tax redistribution: the relative weight of taxes on top quantile adjusted gross income, the proportion of total tax revenue paid by top quantiles, and the effect of taxes on top shares. These measures are compared to previous studies that analyzed tax redistribution based on pre-tax and disposable income shares of the top 20% and 10%, and more recent research combining data sources to study the impact on the top 1% in France.

The analysis reveals significant differences across European countries in the impact of taxes on income redistribution. Table 1 shows tax rates paid by the top 10% and 5%, along with national average tax rates. While the Netherlands exhibits the highest tax rates for top income groups, a clear geographical pattern is absent. Southern European countries, along with the UK and Ireland, show a higher share of total taxes paid by top income groups (Figure 1). Figures 2 and 3 illustrate the redistributive impact of taxes on top income shares, with Portugal, the UK, and Ireland exhibiting the highest reductions. However, the relationship between pre-tax inequality and the impact of tax redistribution is not linear (Figures 3 and 4). Based on these findings, the study identifies four distinct profiles: 1. **Unequal Redistributive:** High pre-tax inequality and high tax redistribution (Mediterranean countries, UK, Ireland). 2. **Unequal Reproductive:** High pre-tax inequality and low tax redistribution (Baltic countries, Serbia, Cyprus). 3. **Even Redistributive:** Low pre-tax inequality and high tax redistribution (Nordic countries, Slovenia, Netherlands, Malta, Croatia). 4. **Even Reproductive:** Low pre-tax inequality and low tax redistribution (primarily Eastern European countries). Bulgaria stands out as an outlier with a regressive tax system. Tables 2 and 3 provide detailed data on the top 10% and 5% shares of adjusted gross and net income, respectively, for each country, illustrating the varying degrees of redistributive impact across the four identified profiles.

The typology presented reveals a diverse landscape of income distribution and tax redistribution across Europe, with geographical patterns that are not always straightforward. The paper compares the findings to existing welfare state regime typologies, highlighting that while Nordic countries demonstrate synergy between labor market institutions, social policies, and taxation to achieve greater equality, Southern European and Anglo-Saxon countries rely more on progressive taxation to mitigate market income inequality. Although taxation can significantly reduce inequality, its effectiveness faces limitations, particularly in addressing already high levels of pre-tax market income inequality. The paper argues that policies aiming for greater equality should focus not just on taxation but also on labor market institutions and addressing educational inequalities. While even pre-tax income distribution doesn't negate the need for equality-oriented tax policies, as illustrated by the Nordic countries.

The study concludes that taxation is a crucial tool for income redistribution, but its effectiveness varies greatly among European countries. The flat taxation of capital income poses a significant challenge to progressive tax systems, requiring greater attention and potentially policy coordination to implement more effective strategies to tackle income inequality. The study suggests considering more progressive taxation of capital income or returning to taxing aggregate income as potential solutions. The diverse profiles identified underscore the need for nuanced and context-specific policies rather than a one-size-fits-all approach.

The study acknowledges limitations inherent in using survey data, particularly the difficulty in accurately capturing the very top income earners. The aggregation of personal income taxes and social security contributions into a single variable may also obscure nuanced differences in the redistributive effects of these separate components. Finally, the cross-sectional nature of the data limits the ability to make causal inferences about the relationships between inequality and tax policies.