The strength of fiscal redistribution is measured by the level of taxation and transfer.

For the most part, advanced countries already have strong fiscal redistribution systems, as reflected in relatively high levels of taxes and transfers. The existing set of tools at their disposal means that these countries can closely approximate the optimal income tax schedule discussed above through a combination of means-tested social assistance transfers (high MTRs at the bottom), consumption taxes (flat tax in the middle), and progressive income taxes (increasing MTRs at the top). In many countries these are complemented by categorical transfers including child benefits and social pensions, as well as comprehensive social insurance systems. However, there are some areas where these systems could be further strengthened (IMF, 2017):

 Personal income taxation (PIT): There appears to be room in many advanced countries for increasing the progressivity of income taxes, which has fallen in many countries since the 1980s.22 Top marginal PIT rates have declined significantly since 1980. The progressivity of income taxes is often even lower than suggested by statutory rates due to the proliferation of tax exemptions which can be more easily exploited by high-income individuals through aggressive tax planning (Alstadsaeter, Johannesen, and Zucman, 2018). Recent empirical studies suggest that in many countries progressivity could be enhanced without adversely affecting economic growth (Gerber et al., 2018). In the context of increasing income volatility and income uncertainty driven by rapid technological change, more progressive income tax systems will also strengthen the insurance role played by fiscal redistribution.

 Capital income taxation (CIT): Efficiency and fairness principles point to the need for equal tax treatment of income regardless of source. Yet capital income (including profits, interest, and capital gains) is typically taxed at a lower rate than labor income, and this rate has been declining in many countries over recent decades23. Also, capital income is typically more unequally distributed than labor income and its share in total income has been steadily increasing over recent decades. Strengthening efficiency, equity and fairness of the income tax system will require better integration of PIT and CIT systems (to reduce incentives to reclassify income), reducing opportunities for tax evasion and avoidance, and addressing the challenge posed by increasing international mobility of the tax base.

 Wealth taxation: Taxation of wealth itself (rather than income returns on wealth) can further strengthen the progressivity and fairness of the tax system, especially since high-income individuals often consume only a small proportion of their income and wealth over their lifetimes and taxing capital returns can be administratively and politically difficult. However, some OECD countries have moved away from this kind of tax on revenue, efficiency and administrative grounds (OECD, 2018). Taxation of immovable property, such as real estate or land taxes which are typically seen as both equitable and efficient, are underused in many countries. Norregaard (2015) estimates additional revenue potential at around 2 percent of importance of having accurate valuation systems.

 Consumption taxation: Enhancing the C-efficiency24 of consumption taxes could increase revenues by over 1 percentage point of GDP in many advanced economies (de Mooij and Keen, 2012). More efficient taxation of fossil fuel consumption to internalize negative domestic and global environmental externalities can also enhance the progressivity of consumption taxes. Coady and others (2019) estimate that efficient taxation of fossil fuels would increase tax revenues by nearly 3 percentage points of GDP on average in advanced countries. However, gaining political support for such tax increases would probably require clarity on how these revenues would be returned to the population to mitigate the adverse welfare impact of price increases, including possibly a universal (or near universal) income transfer (IMF, 2017) which would further enhance fiscal redistribution.

 Means-tested transfers. Most countries have some form of General Minimum Income (GMI) program that provides means-tested transfers to lower-income groups. However, evidence suggests that the disincentive for employment and labor supply is high due to high marginal tax rates (MTRs) as benefits are withdrawn as income rises. Reducing these high MTRs can enhance both the efficiency and equity of fiscal redistribution, especially with greater use of in-work benefits and wage subsidies (Immervoll and others, 2007; IMF, 2019; de Mooij, 2015), if lost revenues are recouped through higher top MTRs and efficient consumption taxes. Efficiency can be further enhanced through strengthening active labor market programs that condition benefit eligibility on job search and participation in training or public employment.

Emerging25 and Developing Countries

Many emerging and most developing countries have much weaker fiscal redistribution systems reflecting administrative constraints on both the tax and spending sides. They also have other significant development challenges that require higher public spending on physical investment (e.g., roads, water, electricity) and human capital investment (e.g., education and health), which are crucial for promoting inclusive growth and for longer-term poverty reduction. Strengthening fiscal redistribution will require an expansion of broad-based consumption taxes and selective excise taxes as well as the development of progressive income tax systems.