Four Levers of Redistribution: The Impact of Tax and Transfer Systems on Inequality Reduction

Using observational micro data from the Luxembourg Income Study (LIS) we assess the redistributive impact of tax and transfer cofigurations across 22 OECD countries for the period 1999-2013. After imputing missing tax data (employer social security contributions), we measure the reduction of income inequality due to four key levers of tax and transfer systems: the average tax rate, tax progressivity, the average transfer rate, and transfer targeting. Our methodological improvements provide the following results: First, tax redistribution dominates transfer redistribution (excluding pensions) in most countries. Second, targeting explains very little of the cross-country variation in inequality reduction. In contrast, both progressivity of taxes and the average tax rate have large impacts on redistribution. Third, we observe the trace of political trade-offs. High average tax rates do not appear in conjunction with highly progressive tax systems.