An analysis of the impact of tax systems on income distribution, poverty, and human well-being: Evidence from cross-country comparisons
Pippin, Sonja Engeli
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The question "what is a good tax?" has been addressed many times in the past. While much optimal taxation research focuses on economic effects of taxation, the purpose of this study is to add a new dimension by investigating the relationship between tax system variables and certain aspects of social welfare other than traditional economic variables. To that end, relationships between four dimensions of a country’s tax and transfer system – (i) progressivity, (ii) overall tax burden, (iii) income tax reliance (i.e., the proportion of total tax revenues from income taxes), and (iv) residual tax burden (i.e., overall tax burden net of income taxes) – and three dependent variables – (i) income inequality, (ii) poverty, and (iii) collective happiness – are examined. These correlations are tested using data from North America, Europe, and Australia. Previous studies have shown that, on average, Americans feel less negatively about inequality and poverty than Europeans. If these beliefs affect the design of the respective tax and transfer systems, differences in effects of tax system variables on income inequality, poverty, and collective happiness are probable. Specifically, tax system progressivity and overall tax burden are expected to impact income inequality, poverty, and collective happiness less in the United States than in Europe. Consequently, this study also examines the differences in the impact of tax system variables on income inequality, poverty, and collective happiness across tax and transfer systems in the United States and in Europe. The results show that progressivity and overall tax burden appear to be negatively correlated with income inequality and with poverty. Furthermore, the redistributive and poverty-reducing effect of transfer progressivity – defined as the reduction of income inequality due to transfers – appears to be much more important than the effect of tax progressivity – defined as the redistribution of income due to taxes –, suggesting that, for tax policy decisions, it is essential to take the entire tax and transfer system, i.e., government revenues and expenditures, into consideration. Moreover, this study provides evidence that some tax system variables (i.e., overall tax incidence and income tax reliance) are positively associated with collective happiness indicating that a high tax burden does not necessarily impact human well-being in a negative way. Contrary to expectations, only few differences in effects between United States tax system variables and European tax system variables were found. This is surprising since the United States and European tax and transfer systems differ significantly from each other in every dimension addressed in this study.