Income distribution and Tax
and Government Social
Spending Policies in
Developing Countries
Sanjeev Gupta
Fiscal Affairs Department
International Monetary Fund
January 28, 2003
1
Introduction

Increasing economic interdependence and some
evidence of widening income disparities have hightened
interest in income distribution, particularly given the
ongoing debate on globalization.

In this context, what should be the role of fiscal policy
as a redistributive instrument in the short and long run?

What should be the role of redistributive tax and
expenditure policies in developing countries?

Is expenditure policy better for affecting income distribution
in developing countries?
2
This presentation:

Provides an overview of changes in income
distribution in developing countries over time
on the basis of available data.

Assesses the incidence of tax and government
expenditures based on existing studies of
individual countries.
3
Outline
Changes in Income Distribution
I.
A.
B.
The role of taxes and social spending
II.
A.
B.
C.
III.
Survey of chages in income distribution
Distribution in industrial versus developing
countries.
Determinants of Income inequality
Tax incidence
Benefit incidence
Conclusions
4
I. Changes in Income Distribution

In recent decades, many developing countries have
experienced an increase in income inequality.


Both in terms of before-tax (after transfer) and after-tax
income (after transfer).
There are many conceptual difficulties in such an
analysis.



Market income
Disposable income
Disposable income combined with government inkind
transfers (eg. education and health).
5
A. Survey of changes in income
distribution

Based on a sample of 19 countries for the 1970s
and 1980s, the average Gini coefficient was
stable, although this masks considerable changes
for some countries.

For example, inequality (as measured by the Gini
coefficient) increased by one point for Venezuela,
but fell by the same amount in Jamaica, Panama, and
Mexico.
6
Table 1. Nineteen Developing Countries: Income Distribution, 1970s-1980s
(in percent unless otherwise indicated)
Gini
Average
of which:
Venezuela
Jamaica
Costa Rica
Trinidad
Guatemala
Colombia
Panama
Mexico
All countries
"b" countries
"a" countries
b
b
a
b
b
b
b
b
1970s (1)
Shares
Q1
Q5
Ratio
Q5/Q1
Gini
1980s (2)
Shares
Q1
Q5
Ratio
Q5/Q1
Change (3)=(2) - (1)
Shares
Ratio
Gini
Q1
Q5 Q5/Q1
44
46
36
5
5
7
50
51
44
12
13
7
44
46
36
5
5
7
49
51
44
11
12
7
0
0
-1
0
0
0
0
0
-1
-1
-1
0
43
45
47
49
50
52
53
54
5
4
4
2
6
5
3
3
47
50
53
51
54
58
57
60
10
12
15
23
9
13
24
22
44
43
46
42
59
51
52
53
5
5
4
3
2
4
3
4
49
49
51
45
63
56
56
58
10
9
13
13
27
15
21
16
1
-1
-2
-7
9
0
-1
-1
0
1
0
1
-3
-1
0
1
2
-1
-2
-7
9
-2
-1
-3
0
-3
-2
-10
17
2
-3
-6
Source: Deininger and Squire (1996).
"b" = Based on before-tax income
"a" = Based on after-tax income
7

Based on a sample of 10 countries for the 1980s
and 1990s, the average Gini coefficient increased
by three percentage points in the 1980s, again
masking larger changes for some countries.

For example, the Gini coefficient in Peru
deteriorated by 2 percentage points, while in
Colombia it remained constant.
8
Table 2. Ten Developing Countries: Changes in Income Distribution, 1980s-1990s
(in percent unless otherwise indicated)
Gini
Average
Of which:
Colombia
All
"b" countries
"a" countries
b
1980s (1)
Shares
Ratio
Q1
Q5 Q5/Q1
Gini
1990s (2)
Change (3) = (2) - (1)
Shares
Ratio
Shares
Ratio
Q1
Q5 Q5/Q1 Gini Q1
Q5 Q5/Q1
35
35
35
8
7
8
43
43
43
7
8
6
38
38
37
7
7
7
45
45
44
8
9
7
3
3
2
-1
-1
-1
1
2
1
1
1
1
51
4
56
15
51
4
54
15
0
0
-2
0
Source: Deininger and Squire (1996).
"b" = Based on before-tax income
"a" = Based on after-tax income
9

In either period, it is not evident that prolonged
economic growth, in and of itself, while having
a powerful impact on poverty reduction, leads to
an improvement in income distribution.

For example, income distribution deteriorated even
in countries with high growth (Thailand), as well as
low-growth countries (Jordan, transition economies).
10
Changes in Income Distribution
Possible factors underlying these changes include:

The impact on middle-income developing countries of the
opening up of low-income countries (China and India) and
changes in social norms.

It may, for example, for exogenous reasons, have become socially
acceptable to have larger differentials within the workplace. As more
people are remunerated outside the conventional norms, adherence to
these norms becomes weaker, or the socially acceptable range widens.

Opening up of low-income countries may have had an adverse
effect on the wages of unskilled workers in middle-income
developing countries.

Worsening asset distribution in these countries.
11
Inequality and financial crises...

The evidence on countries experiencing financial crises
is mixed, depending on the coverage of data. Some
studies using urban data show that inequality has
increased (Argentina), while other studies using urban
and rural data show that inequality declined in the
aftermath of a crisis (Mexico).

This result happens despite large declines in economic
growth, increased unemployment, and overall increases
in poverty levels.
12
Table 3. Argentina: Average per capita Urban Household
(before-tax) Income by Deciles
Decile
1
2
3
4
5
6
7
8
9
10
Total
May-99
32.0
71.0
98.7
132.6
168.6
206.8
266.2
351.8
494.6
1073.6
282.5
Oct-01
20.4
56.9
89.3
119.5
151.3
195.5
253.8
333.9
489.5
1054.2
271.8
May-02
11.9
37.4
60.0
85.2
115.0
153.6
195.9
256.6
368.2
808.1
207.2
% change
May 99 Oct 01Oct 01
May 02
-36.3
-19.9
-9.5
-9.9
-10.3
-5.5
-4.7
-5.1
-1.0
-1.8
-3.8
Note. Monthly values in 1999 Pesos.
Source: Corbacho, Garcia, and Inchauste (2003). Forthcoming.
-41.7
-34.3
-32.8
-28.7
-24.0
-21.4
-22.8
-23.1
-24.8
-23.3
-23.8
13
Table 4. Argentina: Evolution of the Gini Coefficient – Urban
Households; Panel Income Data
Per capita household income
Initial
Final
May 99-
Oct 99-
May 00-
Oct 00-
May 01-
Oct 01-
Oct-99
May-00
Oct-00
May-01
Oct-01
May-02
0.50
0.49
0.49
0.50
0.50
0.51
0.50
0.50
0.52
0.52
0.52
0.53
Source: Corbacho, Garcia, and Inchauste (2003). Forthcoming.
Table 5. Mexico: Evolution of the Gini Coefficient – Urban and
Rural Houshouseholds; Cross-Sectional Expenditure Data
1992
1996
Household consumption
54.8
52.1
Household income
52.3
49.7
Source: Baldacci, de Mello, and Inchauste (2002). IMF Working Paper WP/02/4.
14
B. Distribution in Industrial and
Developing Countries

Without the redistributive effects of tax and
transfer programmes, income inequality is lower
on average in developing countries than in
industrial countries.

However, industrial countries improve income
distribution effectively through taxes and
transfers.
15
Table 6. Income Distribution in Industrial Countries, 1970s/80s-1990s
Gini
Average Gini
Percent Change in Gini
Market
Income
Disposable
Income 1/
Market
Income
Disposable
Income 1/
44.3
27.7
15.7
5.0
40.4
26.4
3.9
1.3
(1990s)
Average Gini
(1970s/80s)
Percentage-Point Change in Gini
(1970s/80s-1990s)
Sources: OECD, 1997, OECD Economic Outlook , No. 62 (December): 49-59; Oxley, Burniaux,
Dang and d'Ercole (1999, Tables 1, and A1).
1/ Disposable income is defined as sum of 1) earnings, 2) self employment and capital income,
3) transfers received from general government, and 4) direct taxes and social security
contributions paid by individuals.
16
Industrial Countries
In the OECD, a recent study found that market income
inequality has widened in 21 of the 28 member countries for
which data was available. The increased dispersion of gross
earnings has been the main cause with a simultaneous increase in
“work-rich” and “work-poor” shares of households.
Distributional effects of public transfers and taxes
 The effectiveness of taxes and transfers in reducing inequality
and poverty has increased.

Targeting of benefits has increased.

Non-pension transfers form an increasingly large part of the
income of low-income households among the working-age
population in all countries.
17
Developing countries

The before-tax (but after-transfer) Gini coefficients for
developing (and transition) economies are on average
lower than the “market-income” Gini coefficients for
industrial countries [Deninger and Squire, 1996]



1990s Developing countries average
1990s Industrial Countries average
= 38 percent
= 44 percent.
There are indications that tax and transfer programs in
developing (and transition) countries are not as
effective as those in industrial countries.


The before-tax Gini averages 38 percent
The after-tax Gini averages 34 percent.
18
Table 7. Twenty Developing (and Transition) Countries:
Income Distribution, 1990s 1/
Gini
Adj.
Shares
Gini
Q1
Q5
(In percent)
Ratio
Q5/Q1
Per Capita
GNP $
1992
1,585
3,228
Before tax ("b") countries
Median
Mean
Of which:
Colombia
34
38
30
34
6
7
42
44
6
8
51
47
4
54
15
32
34
7
8
41
42
5
6
38
45
7
5
45
50
7
10
ueq
1,330
After tax ("a") countries
Median
Mean
Of which:
Jamaica
Peru
1,035
1,198
ueq
1,340
950
Sources: Deininger and Squire (1996); International Monetary Fund, International
Financial Statistics Government Finance Statistics, and World Bank's World
Development Report, 1994.
* denotes transition countries.
ueq = relatively unequal income distribution (after-tax Gini greater than 40).
Q1 = poorest quintile; Q5 = richest quintile
1/ Each entry in the table corresponds to the latest available observation in the
1990s for each country.
19
II. The role of taxes and social spending
 Taxes
and transfers affect the difference
between market and disposable incomes in the
short and long term.
 Some
taxes affect work efforts of individuals.
 Excessive tax rates can drive economic activity out of
the formal sector or out of the country.
 Social
spending policies have distributional
implications through immediate benefits (health
and education), but also have long-term
implications on earnings capactities.
20
A. Determinants of Income Inequality

A simplistic econometric estimation on the relationship
between income distribution, the tax regime, secondary
school enrollment, urbanization, and inflation was carried
out.

The results show that other things being equal,




Inequality (measured by the Gini coefficient) declines as the ratio
of direct to indirect taxes increases. However, the magnitude of
this effect is small.
Inequality increases with urbanization.
Inflation does not seem to affect the long-term evolution of
income inequality.
The role of secondary education is unclear.
21
B. Tax Incidence Studies

Existing studies on tax and transfer incidence
suggest that the redistributive impact of these
programs is limited in developing countries:

Tax structure in these countries is dominated by
indirect taxes. There is a limited menu of capital and
wealth taxes;

Weak tax administration, high level of evasion, poor
governance, and corruption.
22
Table 8. Developing Countries: Tax Incidence
Strongly progressive
Progressive
Proportional
Insignificant effect
Mixed
Regressive
Strongly regressive
Total
All taxes Direct taxes Income
Payroll
(number of studies)
1
12
1
12
7
1
1
2
8
1
1
7
3
0
1
36
3
14
5
Indirect taxes
2
1
2
5
Source: Survey of country studies, 1971-1995.
23
Tax incidence

Survey conclusions:

Regarding overall tax systems in 19 countries which were
surveyed, 13 of 36 cases reviewed are progressive, 7 are
proportional, 7 are regressive, and the rest have mixed or
insignificant effects.

Regarding income tax systems, 12 of 14 cases are
progressive, 1 is regressive, and 1 has mixed effects.

Some studies report a decline in the progressivity of
direct taxes over time.
24
C. Benefit incidence of government spending
Some concepts:
 Benefit incidence is the analysis of who receives
the benefits of government services.

Expenditure incidence is the analysis of how
government spending affects private incomes.

Spending is well (poorly) targeted if the poorest
quintile’s share of benefits is larger (smaller) than
that of the richest quintile.
25
Benefit incidence of government spending
– (cont’d.)

Spending is progressive (regressive) if the benefits to
the poorest quintile are larger (smaller) than the
benefits to the richest quintile relative to the
respective quintile’s income or expenditure share.

If government spending is well targeted, it will be
progressive. However, progressive spending may not
necessarily be well targeted.

Targeting an expenditure well is more challenging than
making it progressive.
26
Survey of incidence of government
spending

A survey of 55 benefit incidence studies shows
that education, health and transfer programs in
developing countries are generally progressive,
but many are not well-targeted.

31of 55 studies for 25 developing countries find that total
education spending is progressive while 33 studies find that it
is poorly targeted.
27
Table 9. Developing Countries: Incidence of Education Spending
All
Education
Targeting
Good
Poor
Incidence
Progressive
Regressive
Primary
Secondary
(number of countries)
Tertiary
55
22
33
54
42
12
54
23
31
52
0
52
31
31
0
37
37
0
26
26
0
11
6
5
28
Education

Government spending on primary education is reasonably welltargeted in all regions – though the degree of targeting varies.

The poorest quintile in Latin America receives more than 4 times the
richest quintile in terms of primary education whereas the poorest
quintile in sub-Saharan African countries gets only slightly more than the
richest quintile.

On average, outlays for secondary education spending are welltargeted in Asia and Latin America but poorly targeted in subSaharan Africa, the Middle East and in the transition economies.

Tertiary education mostly benefits the richest quintiles in all
regions.
29
Table 10. Developing Countries: Incidence of Health Spending and
Transfers
Health
Transfers
(number of countries)
Health
Targeting
Good
Poor
Inconclusive
Incidence
Progressive
Regressive
Inconclusive
38
21
17
14
4
9
1
30
30
0
15
14
0
1
30
Health Spending & Transfers

21 of 38 studies find that government spending on health
care is well targeted; 30 studies find it to be progressive;
although there is wide diversity across countries.


In Subsaharan Afrca and transition economies, health spending is
poorly targetedl while in Asia and Latin America, the poorest
quintiles receive 1½ and 3 times as much as the richest quintiles,
respectively.
Other government expenditures: transfers are progressive,
but poorly targeted.
 The Food stamp program of Jamaica was well-targeted as was
the self-targeted food subsidies program of Tunisia. Pension and
social security benefits are poorly targeted in Chile, Costa Rica and
Uruguay.
31

Note that the incidence of government
spending programmes is not easy to assess.

For example, government expenditure on an
ineffective primary education program might end up
being a cash transfer to teachers, rather than a direct
benefit for schoolchildren.
32
III. Conclusions

Available data and studies indicate that income inequality in
developing countries is, on average, lower than that in industrial
countries, before taxes and including transfers,

Due to their more effective tax systems, industrial countries are
able to improve income distribution through taxes and transfers.
Most developing countries do not have comparable programs to
achieve post-tax post-transfer income equality as in the industrial
countries.

Sound economic and social policies help either limit a
deterioration, or achieve an improvement in income distribution.
High economic growth alone does not appear to ensure an
improvement in income distribution.
33
Conclusions

Countries that pursued sound macroeconomic and
structural policies, including sound social policies,
improved income distribution, in spite of the limited
focus on equity in their tax reforms.


(Indonesia, Jamaica).
The use of tax instruments for redistribution remains
an interesting issue that needs to be explored.

If the progressivity of the tax system is achieved at the cost
of revenue (relative to a neutral tax regime), the gains in
redistribution from the tax side could be more than offset by
the lost opportunities to use progressive expenditure-policy
instruments.
34
Conclusions

The expenditure side of the budget offers
greater scope for affecting income distribution,
both pre-tax and post-tax. This will, however,
require improved targeting of social programs.

There is scope for further evaluation of policies
using combined incidence studies: the question
is what the combined effect of tax and spending
policies are on income distribution.
35
Thank you.
36
Figure 1. OECD Poverty rates before and after
taxes and transfers, working age population
Source: Förster and Pearson, “Income Distribution and Poverty in the OECD Area: Trends and Driving
Forces” OECD Economic Studies. No. 34, 2001.
37
Figure 2. OECD: Poverty percentage point
changes, mid 1980s to mid-1990s.
Source: Förster and Pearson, “Income Distribution and Poverty in the OECD Area:
Trends and Driving Forces” OECD Economic Studies. No. 34, 2002/1.
38