State action and fiscal redistribution is key to combating racial disparities in economic policy

Opportunities and incentives Fiscal policies can create opportunities for those who would otherwise be disadvantaged. In many economies, advanced and emerging alike, large disparities exist between higher- and lower-income households in terms of access to quality education, health care, and digital technologies. These disparities put children in unequal starting positions. Public spending can, in part, compensate for the gap between rich and poor in private spending on children and help reduce the importance of parental background and other circumstances that are beyond an individual’s control. This is achieved through efforts to ensure access to basic public infrastructure, such as clean water and sanitation; basic health services; and social investments—for instance, in education. These policies can increase intergenerational mobility and also, by facilitating human capital formation, can enhance long-term growth, particularly by increasing education levels among children from disadvantaged backgrounds. Public spending on basic services can be a priority where access gaps are large. However, the type of spending needs to be carefully assessed given country-specific circumstances. For instance, spending on higher education might benefit mostly richer households. Fiscal policies can also influence inequality by providing incentives for labor market participation or children’s education. For example, labor supply and employment can be affected by labor tax wedges, the difference between a worker’s take-home pay and the corresponding total labor cost for the employer, and by participation tax rates, the difference between replacement income received by an unemployed person and his or her expected earnings. This is especially true for second earners. Refundable tax credits for low-income families, individualization of personal income tax filing, and more widely available and affordable childcare could reduce gender bias and encourage labor force participation. Conditional cash transfers, in addition to reducing poverty, can provide incentives for school attendance or regular health checkups. Active labor market policies can support efficient functioning of labor markets, for instance through public employment services that assist the unemployed in finding suitable jobs or government-sponsored vocational training for those most excluded from the labor market. On the demand side, worker retention programs, which have been developed massively in advanced economies throughout the recent crisis, have helped governments invest in maintaining employment linkages. This has contributed to smoother recoveries and helped avoid massive job losses and business failures that would have fed inequality. Redistribution Redistributive policies can curb labor income inequalities. Direct taxes and transfers jointly reduce income inequality by more than one-third in advanced economies. However, in emerging market economies the extent of redistribution is much smaller. Overall redistribution accounts for 85 percent of the disposable income inequality between advanced and emerging market and developing economies. Social transfers help reduce inequality mostly at the bottom, and taxation at the top. Importantly, most of the redistribution is achieved through social transfers—social assistance, unemployment insurance, or pensions. The coverage of the most vulnerable groups and adequacy of the benefits rather than the aggregate level of spending determine the effectiveness of social transfers in terms of reducing poverty and inequality. As is often the case in policymaking, the design is crucial. Well-targeted transfers can help support vulnerable groups while keeping costs manageable. In this respect, the leap in digitalization is a new opportunity for governments. For example, it makes the identification of households and verification of eligibility easier and quicker. As a result, governments can improve coverage and targeting and reduce leakages through fraud, corruption, or errors. More progressive taxation, along with mobilizing revenues to finance social spending, has a large potential to reduce inequality, especially in countries where taxation is relatively low in terms of its overall burden and in its progressivity. Countries can achieve more redistributive tax systems through higher top marginal income tax rates, (in-work) tax credits for low-income households, and limiting loopholes in the taxation of capital income (dividends, interest, and capital gains). Tax policy and administration reforms are also crucial for raising additional revenues, especially in countries with weak tax capacity, to provide financing for social spending. Indirect taxes, such as value-added tax and excises, are major revenue sources for most governments, and they are relatively easy to enforce and collect. While consumption taxes could be regressive, they can support equity objectives if they are used to finance basic public services, such as health care, education, and infrastructure. This is because poor households benefit more from these services than rich households, in proportion to their incomes. Significantly raising revenues from direct taxes requires strong governance reforms and making use of opportunities from digitalization. Among these are real-time data on household expenditures, which can facilitate progressive taxation of consumption. International registers for asset ownership and greater transparency create additional revenue opportunities. Tax administration reforms can generate resources for higher spending on health, education, and social protection.