Contributions of taxes and benefits to vertical, horizontal and redistributive effects

Working Paper 2012-252

Abstract

This paper develops new decompositions of the redistributive, vertical and horizontal effects of the fiscal system, revealing the contributions of different tax and benefit instruments. This new methodology brings together two widely acknowledged approaches in the study of income inequality and redistribution: Kakwani’s (1984) decomposition of redistributive effect into vertical and horizontal effects and Lerman and Yitzhaki’s (1985) decomposition of marginal changes in income inequality into contributions of different income components. The roles of taxes and benefits in achieving vertical, horizontal and redistributive effects are evaluated on the post- and pre-fiscal income margins, as well as on other margins between the borderline ones. Applications to hypothetical and real-world data indicate the suitability of decompositions for cross-country comparisons of tax-benefit systems.

Authors: Ivica Urban.