Over the last five years, Polish families with children have been entitled to a relatively generous benefit of approximately €110 per month and child. Initially granted for every second and subsequent child in the family regardless of income and for the first child for low-income families, the benefit was made fully universal in 2019. With the total costs amounting to as much as 1.7% of Poland’s GDP, the benefit reaches the parents of 6.7 million children and significantly affects these families’ position in the income distribution. Its introduction has led to a substantial reduction in the number of children living in poverty. However, since families with children are more likely to be among households in the upper half of the income distribution, out of the total cost of the benefit, a proportionally greater share ends up in the wallets of high-income families. While the implementation of the benefit has significantly changed the scope of public support to families in Poland, there are many lessons to be learnt and some important revisions to be undertaken to achieve an effective and comprehensive support system.
One of the principal commitments in the 2015 Polish parliamentary elections of the then-main opposition party – Law and Justice (Prawo i Sprawiedliwość, PiS), was introducing a generous child benefit. The purpose of this benefit was to support families and encourage higher fertility, which had been one of the lowest in the European Union for a long time. Following PiS’s electoral victory, the new government introduced a semi-universal child benefit of approximately €110 per month (exactly 500 PLN per month, thus the Polish nickname of “the 500+ benefit”) in April 2016. Initially, the benefit was granted for every second and subsequent child in the family regardless of income and for the first child in low-income families. Since July 2019 (nota bene three months before the next parliamentary elections), it was made universal – all parents with children under the age of 18 are entitled to 500PLN per month for every child. The benefit is relatively generous (for comparison, it accounts for 17.9% of the minimum wage in Poland in 2021), and universal coverage implies substantial costs for the government budget, totalling about 41bn PLN per year (1.7% of the Polish GDP).
Over the last five years, a number of analyses of the consequences of the benefit’s introduction have been conducted. These have encompassed a variety of socio-economic outcomes for Polish families with children – from a comprehensive assessment of these consequences (Magda et al. 2019) to analyses focused on specific effects of the benefit, such as the impact on women’s economic activity (Magda et al. 2018, Myck 2016, Myck and Trzciński 2019) or poverty (Brzeziński and Najsztub 2017, Szarfenberg 2017). The fifth anniversary of the benefit’s implementation seems to be a good opportunity for a summary and update of previous evaluations of the distributional consequences and financial gains for households resulting from this policy (an overview of all the previous CenEA analyses of the child benefit can be found in CenEA 2021). The results presented in this brief are based on analyses conducted using the Polish microsimulation model SIMPL on data from the 2019 CSO Household Budget Survey (more details in Myck et al. 2021). It should be noted that the analyses do not account for the impact of the Covid-19 pandemic on the material situation of households, as the data was collected before the outbreak. As previous studies suggest, the consequences for households of the pandemic and the series of resulting lockdowns varied greatly depending on various factors, such as the sources of income, sector, and form of employment, thus making it impossible to estimate precisely (Myck et al. 2020a).
The Child Benefit on Household Incomes
Due to its universal character, the distributional consequences of the child benefit payments are directly related to the position of households with children aged 0-17 in the income distribution relative to those without. As households with children are more likely to be in the upper half of the distribution (taking into account the demographic structure of households through income equivalisation), out of the total budget expenditure on the benefit, a proportionally greater share goes to high-income families (Table 1). Families with children in the two highest income decile groups (i.e., belonging to the 20% of households with the highest income) currently receive almost 25% of the total annual expenditure on the child benefit. On the other hand, among the 20% of households with the lowest incomes, families with children receive only 11.7% of the total annual cost of the benefit.
Table 1. Household gains resulting from the child benefit by income decile groups
Compared to the poorest 10% of households, families with children in the highest income decile receive 2.5 times more of the total funds allocated to the benefit.
It is also worth noting that the proportion of benefit in the disposable income is relatively evenly distributed if one considers all households in a given decile (with and without children). The proportional benefits in the first nine income deciles are in the range of 3.4% and 5.3% and only fall to 1.9% in the highest income group. A significant differentiation of the benefit in proportional terms can only be seen when accounting solely for households with children within each income decile. The benefit amounts to as much as 26.9% of the disposable income of households with children in the first decile, and the effect falls in subsequent groups – from 18.9% and 16.4% in the second and third deciles, to only 4.1% in the top decile.
The Child Benefit and the Position of Families With Children in the Income Distribution
Taking into account the magnitude of the policy, the position of families with children in the income distribution relative to other households may, to some extent, be the result of receiving the benefit itself. It is, therefore, reasonable to ask what role the benefit plays in shaping this relative position in the income distribution. Figure 1 presents the number of children under 18 in households by income decile groups when the benefit is included in total household income (left panel) and in a hypothetical scenario when the child benefit payment is withdrawn (right panel). As we can see, the withdrawal of the benefit would cause a substantial change in the relative position of families with children in the income distribution, significantly increasing the number of children in the lowest income groups. While in the current system, the poorest 10% of households include 342 thousand children aged 0-17, this number would be 553 thousand in a system without the benefit. However, the benefit also changes the relative position of high-income households with children. In the current system, the richest 10% of households include 762 thousand children. Subtracting the benefit from their household income would reduce this number to 687 thousand.
Figure 1. The child benefit and its impact on the position of families with children in the income distribution
Thus, even when taking into account the income distribution without the benefit, the number of children among the richest 10% of households is almost 25% higher than the number of children in the poorest 10% of households. Looking at the income distribution after including the benefit, there are more than twice as many children in the richest 10% of households than among the poorest 10%. This, in turn, inevitably means that, out of the total cost of the benefit, over twice as much money is transferred to households belonging to the richest deciles as compared to the funds transferred to families belonging to the poorest 10% of households.
With the total costs amounting to 1.7% of Poland’s GDP, the child benefit introduced in April 2016 substantially raised the level of direct financial support for families with children. As shown in this brief, the benefit reaches the parents of 6.7 million children aged 0-17 and significantly affects the position of these families in the income distribution. While, on the one hand, a large proportion of families with children have incomes high enough to be in the highest income groups even without this support , the lowest decile group would include over 200 thousand more children in the absence of the benefit. This confirms that the child benefit alone contributes to a significant improvement in the material conditions of families with children and to a significant reduction in poverty (cf. Brzezinski and Najsztub, 2017; Szarfenberg, 2017). However, the scale of this reduction is modest given the size of the resources involved. This is not surprising given that the bulk of the total costs of the benefit comes from the 2019 program extension to cover all children regardless of family incomes, which largely ended up in the wallets of higher-income families (Myck et al. 2020b). One of the key goals of the benefit upon introduction was to increase the number of births in Poland by easing the material conditions of families with children. Yet despite a radical increase in the level of support, the number of births in Poland over the period 2017-2020 has essentially remained the same as that forecasted by the Central Statistical Office in its long-term population projection of 2014 (Myck et al. 2021). It is thus difficult to consider the benefit a success in terms of this major objective. Moreover, the withdrawal of the income threshold has largely eliminated the negative disincentive effects of the benefit with regard to employment (Myck and Trzcinski 2019). However, it is unclear whether the post-pandemic economic situation will allow for an increase in female labour force participation, which declined following the introduction of the benefit in 2016 (Magda et al., 2018).
The effects of every socio-economic programme should be assessed by comparing cost-equivalent alternatives. Despite all gains the “500+” child benefit has brought to millions of families in Poland over the last five years, the flagship programme of the ruling Law and Justice party does not fare well in this perspective. The need for change seems much broader than the reform of the benefit alone. The benefit was introduced on top of two other financial support mechanisms focused on families with children, namely family allowances and child tax credits, and the three elements have been operating in parallel since 2016. A number of suggestions on creating a streamlined, comprehensive system have been made a long time ago (e.g., Myck et al. 2016). However, a major restructuring of the entire support system with clearly defined socio-economic policy goals in mind seems all the more justified now, when many families may require additional assistance due to the difficult financial situation related to the Covid-19 pandemic.
This Policy Brief draws on the CenEA Commentary published on 31.03.2021 (Myck et al. 2021). It has been prepared under the FROGEE project, with financial support from the Swedish International Development Cooperation Agency (Sida). The views presented in the Policy Brief reflect the opinions of the Authors and do not necessarily overlap with the position of the FREE Network or Sida.
- Brzeziński, M., Najsztub, M. 2017. The impact of „Family 500+” programme on household incomes, poverty and inequality”, Polityka Społeczna44(1): 16-25.
- CenEA 2021. Childcare benefit 500+ in CenEA analyses. https://cenea.org.pl/2021/04/06/childcare-benefit-500-in-cenea-analyses/
- Magda, I., Brzeziński, M., Chłoń-Domińczak, A., Kotowska, I.E., Myck, M., Najsztub, M., Tyrowicz, J. 2019. „Rodzina 500+– ocena programu i propozycje zmian”. (“Child benefit 500+: the evaluation of the programme and suggestions for changes”), IBS report.
- Magda, I., Kiełczewska, A., Brandt, N. 2018. “The Effects of Large Universal Child Benefits on Female Labour Supply”, IZA Discussion Paper No. 11652.
- Myck, M. 2016. “Estimating Labour Supply Response to the Introduction of the Family 500+ Programme”. CenEA Working Paper 1/2016.
- Myck, M., Król, A., Oczkowska, M., Trzciński, K. 2021. “Świadczenie wychowawcze po pięciu latach: 500 plus ile?”(„The child benefit after 5 years – 500 plus what?”), CenEA Commentary 31/03/2021.
- Myck, M., Kundera, M., Najsztub, M., Oczkowska, M. 2016. „25 miliardów złotych dla rodzin z dziećmi: projekt Rodzina 500+ i możliwości modyfikacji systemu wsparcia” („25 billion PLN to families with children: Family 500+ programme and possible modifications of the family support system”), CenEA Commentary 18/01/2016.
- Myck, M., Oczkowska, M., Trzciński, K. 2020a. “Household exposure to financial risks: the first wave of impact from COVID-19 on the economy”, CenEA Commentary 23/03/2020.
- Myck, M., Oczkowska, M., Trzciński, K. 2020b. „Kwota wolna od podatku i świadczenie wychowawcze 500+ po pięciu latach od prezydenckich deklaracji” („Tax credit and child benefit 500+ after five years since electoral declarations”, in PL), CenEA Commentary 22/06/2020.
- Myck, M., Trzciński, K. 2019. “From Partial to Full Universality: The Family 500+ Programme in Poland and its Labor Supply Implications”, ifo DICE Report 17(03), 36-44.
- Szarfenberg, R. 2017. “Effect of Child Care Benefit (500+) on Poverty Based on Microsimulation”, Polityka Społeczna 44(1): 25-30.
Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.
Taxes and benefits create incentives for people to adopt or avoid certain behaviours. They create premiums for (socially) preferred states. A premium can be determined by either taxing unwanted behaviour or by subsidizing desired behaviour. The resulting economic incentive for changing one’s behaviour is nominally equivalent under both mechanisms. However, the choice of frame for an incentive to be either described in terms of a tax or as a benefit can strongly influence perceptions of what is fair treatment of different, e.g. income, groups. Using a survey-experiment with Flemish local politicians, we show policy-makers to be highly susceptible to such tax and benefit framing effects. As such effects may (even unintendedly) lead to sharply different treatment of the same group under the two mechanisms, important questions arise, particularly for the design of new tax and benefit schemes.
The design and implementation of redistributive policies usually evoke much discussion. Opinions, both in public and often also in political debate, tend to be driven by ethical and fairness considerations. However, such concerns can lead to unintended consequences and – at least in terms of ex-ante intended fairness – to ex-post imbalanced incentive structures for different (income) groups.
An important function of taxes and benefits is the creation of premiums for certain behaviours or actions. Either unwanted behaviour may be taxed and thereby sanctioned, or desired behaviour may be encouraged through benefits. Irrespective of the method chosen, an economic incentive is created for individuals to opt for the desired behaviour.
The way such premiums are defined can usually be thought of as a two-step process. First, a baseline for a given behaviour, action, or state is chosen as a reference-point. For instance, baseline behaviours could be to not have retirement savings, to not use safety-certified equipment or follow accepted standards at work, or to not have children. Arguably, these are cases warranting the creation of incentives to encourage people to adopt the socially desirable behaviours of saving money for their old age, working in a safe environment, and having children. The second step, then, requires a choice of mechanism to create an incentive. The mechanism can be to either punish the unwanted behaviour – such as not adhering to safety standards at work – or to grant (cost-reducing) subsidies and benefits for taking the desired action, such as saving for old age or having children.
Importantly, the combination of the chosen reference point and the mechanism to create the incentive can influence the way people think about the fairness of an incentive when the targets belong to different (income) groups. Schelling (1981) demonstrated this point in an in-class experiment, which, somewhat simplified, runs as follows:
Families typically receive some child benefit: they get a certain sum per child. Imagine there are two families, one poor and one rich, both with their first child. What amounts of child benefit should each family get? Should the poor get more than the rich, should both families get the same, or should the rich family get more for having a child than the poor family? Schelling’s students would tend to voice support for either the poor getting more or both families getting the same. After all the rich family is surely already affluent enough to support their child. At the extreme, the rich family would get nothing for having a child, and the poor family quite a lot.
Now think of a world where the standard is to have a child, and couples who do not have a child have this ‘socially undesirable’ behaviour ‘penalised’ through a fee, for instance in the form of a tax. Should the poor couple pay a higher fee, should both couples pay the same, or should the rich couple pay a higher fee? The students now overwhelmingly supported requiring the rich couple to pay more. After all, they have more disposable income. However, in this case, the rich couple receives a lot for having a child (they no longer need to pay the steep fee), whereas the poor family may get no (additional) economic incentive for having a child. The treatment of the same family thus obviously drastically differs between the two frames. At the extreme, the poor family gets quite a lot for changing from having no children to having one child in the first frame, but nothing in the second frame. For the rich family, the situation is the reverse: there is no premium for having a child in the first frame, but potentially quite a high premium for having a child in the second frame.
Does this thought-experiment matter outside the classroom (see also Traub 1999, McCaffery & Baron 2004), beyond the context of child benefit, and among those actually exposed to the design considerations of tax and benefit systems? In a recent paper (Kuehnhanss & Heyndels 2018), we test the occurrence of such framing effects with elected local politicians in Flanders, Belgium, who are involved in the budgetary decision-making in their municipalities.
We invited 5,928 local politicians to take part in an online survey on economic and social preferences in spring 2016. Participation was voluntary, not incentivised, and questions were not compulsory, allowing respondents to skip them if they so chose. In total, 869 responses to the survey were registered and (N1=) 608 participants provided usable answers to the questions relevant to the framing effect described above.
Participants were randomly allocated to one of two groups, each receiving a slightly different wording of the following question:
“In Belgium couples receive financial benefits from the state. Suppose that it is not relevant how the transfer is funded, and ignore any other benefits, which might come into play. How much [more / less] should a couple [with their first child / without children] receive per month than a couple [without children / with their first child]?”
One group saw the question in the benefit frame with only the italicised phrases in the brackets displayed; the other group saw the question in the tax frame with only the phrases in boldface displayed. In both groups, participants were then asked to fill in amounts they would consider appropriate for each of three couples with different monthly net incomes: €2,000, €4,000, or €6,000, respectively.
With framing effects – and distinct from classic rational choice models – the expectation is that the three couples would be treated differently depending on the phrasing of the question. In the italicised benefit version the amount granted should be decreasing with the income of the family. In the boldface tax version the stated amount should be increasing with the families’ income.
Figure 1. Results child scenario
Source: Kuehnhanss & Heyndels (2018, p.32)
As Figure 1 shows, the results strongly conform to this pattern. The low-income (€2,000) couple is granted an average of €330 in the benefit frame, but only €178 in the tax frame (recall that the premium in the latter arises from no longer receiving less – or ‘paying a fee’ – once there is a child). For the high-income (€6,000) couple, the amounts granted average €132 in the benefit frame, but a much higher €368 in the tax frame.
Environmental taxes and benefits
Child benefit systems are usually a well-established part of countries’ tax and benefit systems. The design of new instruments is more common in policy areas undergoing, for instance, technological change or being newly regulated. A relevant example is policy on the promotion of environmentally friendly behaviour and technologies, e.g. through ‘green’ taxes and subsidies. To test the validity of the hypothesised framing effect, we also included a second scenario in our survey related to the municipal interests of our respondents, namely car taxes. Flemish municipalities receive income from a surcharge levied on the car taxes paid by motorists. Consequently, we asked our participants (N2 = 525, see the paper for details) to imagine the introduction of a new environmental certificate for cars in Belgium, and to provide amounts they would consider appropriate for the difference in annual tax paid on cars with or without the certificate. Specifically, roughly one half of participants was asked how much less the owner of a certified car should have to pay in annual car tax than the owner of a non-certified car (the subsidy frame). The other half was asked how much more the owner of a non-certified car should pay in annual car tax than the owner of a certified car (the tax frame). The question was again asked for three different levels, proxying wealth via the cost of the cars: €15,000, €30,000, and €45,000, respectively.
Figure 2. Results car scenario
Source: Kuehnhanss & Heyndels (2018, p.32)
Figure 2 shows the results. The effect is less pronounced in this scenario, as the slope for the granted amounts in the subsidy frame remains largely flat or slightly increases. Nonetheless, a substantial framing effect remains. In the tax frame, the amount of the premium (i.e. the amount of taxes no longer owed once a certificate is obtained) strongly increases with the cost of the car. Taking the most expensive car (€45,000) as an example, we thus observe differential treatment across frames also in this scenario. In the subsidy frame, the premium for having a certificate is €778, in the tax frame it is a much higher €1,333.
These results suggest a strong and economically meaningful effect of framing among policy-makers with a stake in tax and benefit systems. While the exact mechanism driving the results invites further research, the strongly divergent premiums, and hence distribution of incentives, across baseline frames raise concerns of unintended effects in the design of taxes and benefits. Especially new schemes – e.g. ‘green’ policy, reform, or regulatory expansion – may benefit from increased scrutiny in the design process. Awareness of susceptibilities to framing and its potential influence on the formulation of individual tax and benefit instruments may help to align intended fairness, incentive structures, and redistributive outcomes.
- Kuehnhanss Colin R.; and Bruno Heyndels, 2018. ‘All’s fair in taxation: A framing experiment with local politicians’ Journal of Economic Psychology, 65, 26-40.
- McCaffery, Edward. J.; and Jonathan Baron, 2004. ‘Framing and taxation: Evaluation of tax policies involving household composition’ Journal of Economic Psychology, 25(6), 679–705.
- Schelling, Thomas C., 1981. ‘Economic reasoning and the ethics of policy’ Public Interest, 63, 37–61.
- Traub, Stefan, 1999. Framing Effects in Taxation. Heidelberg: Physica-Verlag
Belarus proudly calls itself a social state. Indeed, Belarus boasts one of the lowest poverty and inequality levels in the region. Fiscal policy in Belarus is equalizing and pro-poor, effectively redistributing income from rich to poor. As in Russia and many other Post-Soviet states, the equalizing effect of the fiscal policy in Belarus is mostly attributable to the pension system. Some of the other social policies are highly inefficient, failing to redistribute income. The prominent examples are utility subsidies and student stipends, which mainly benefit the upper part of the income distribution. The lack of adequate unemployment benefits is an opportunity to improve the efficiency of the social support system in Belarus.
The Constitution of Belarus characterizes Belarus as a social state, and Belarus takes its social state status seriously. The economic growth in the beginning of the 2000’s was strongly pro-poor (Chubrik, 2007). Poverty according to the national definition (calorie-based poverty line, which in 2015 corresponded to $10.67 PPP per day) declined from 42% in 2000 to 5.7% in 2016, while the poverty according to the international threshold of $3.1 per day in PPP terms is fully eradicated. Belarus also has one of the lowest levels of income inequality in the region with a Gini coefficient of only 0.27 (UNDP, 2016).
How much of the pro-poor and equalizing effects could be attributed to the government policy? Probably it is impossible to give a complete answer to the question. Many non-formalized and not easily quantifiable government policies lead to the decrease in poverty and inequality. For example, the policy of support to state-owned enterprises might have redistributive effects through job creation. However, the absence of access to relevant data makes it impossible to estimate the effects of the policy.
Some of the government policies, on the other hand, are easily quantifiable with available data. Bornukova, Chubrik and Shymanovich (2017) analyze the redistributive effects of fiscal policies in Belarus using the Commitment to Equity methodology (Lustig, 2016). The authors find that the direct taxes and transfers in Belarus (taxes, transfers, and subsidies) are equalizing and pro-poor, lowering the national poverty headcount by 17 percentage points and the income Gini coefficient from 0.41 to 0.27. The high equalizing effect of the fiscal policies in Belarus surpasses those in other developing countries, including Russia where the direct taxes and subsidies reduced the income Gini coefficient by 0.13 (Lopez-Calva et al., 2017). The remaining discussion in this brief is based on the results from Bornukova, Chubrik and Shymanovich (2017), if not otherwise stated.
Fiscal policies and their redistributive effects
The two types of direct personal taxes – the personal income tax and the social contributions tax – are both almost flat in Belarus. To fight tax evasion, the Belarusian authorities introduced flat tax rates in 2009, following a successful experiment in Russia. The personal income tax has some small exemptions for families with children, while the social contributions tax has a lower rate for agriculture employees. However, the effect of these deductions is relatively small: the direct taxes decrease the Gini coefficient by only 0.015.
The indirect taxes – the value-added tax, the import duties, and the excises – are weakly regressive, putting the burden of taxation on the poor. This is particularly true for the alcohol and tobacco excises. Again, the main purpose of these taxes is to penalize unwelcome behavior, and not to redistribute income, hence the result is not unexpected, and common for many countries. Overall the indirect taxes in Belarus increase the Gini coefficient by 0.05.
Direct transfers are responsible for most of the equalizing effects of the fiscal policies. This is not surprising, given that the main purpose of the direct transfers is to fight poverty and provide support for those in need. However, most of the transfers are not need-based or targeted to the poor. Instead they are assigned to households based on their socio-economic characteristics aside income, such as age and maternity status.
Pensions are the main factor of reducing poverty and inequality. They reduced the Gini coefficient by 0.11 and decreased poverty (according to national definition) by 19 percentage points. The incredible effectiveness of the pensions is largely explained by the absence of other sources of income of the retirees. The majority of them does not work, and have no other pension savings or passive income. Pensions in Belarus are also redistributive in nature since they only weakly depend on one’s income during the working life.
Different benefits and privileges also decrease poverty and inequality, but at a much smaller scale. The childcare benefits (for families with children aged 0-3 years) contribute most to the effects, decreasing the Gini coefficient by 0.013 and poverty by 3 percentage points. The variety of privileges does not contribute much due to their relatively small size.
Utilities and transport subsidies are also important elements of the social support system, and their existence is usually justified by the necessity to support those in need. Since the utilities subsidies are incorporated into tariffs and available for everyone independent of need, they are in fact benefitting the rich (i.e. people with big apartments and houses).
Figure 1. Incidence of utilities subsidies by income deciles
As seen on Figure 1, upper deciles receive more support through utilities subsidies, and this support is quite substantial, often surpassing $1 per day in PPP. However, as a share of income the utilities subsidies are still progressive, and they in fact decrease the Gini coefficient by the tiny amount of 0.006, and decrease poverty (as any handout). The same is true for transport subsidies.
What could be improved?
Due to the flat nature of direct taxation and an absence of well-targeted needs-based transfers, some of the people in need still fall through the cracks. 1.9% of the population actually becomes poor after we account for the direct taxes and transfers. This headcount increases to 3.3% if we account for indirect taxes.
Another important issue is the efficiency of government transfers and subsidies in fighting poverty and inequality. It is not surprising that pensions have the largest equalizing contribution, as the government spends almost 11% of GDP on pensions. If we account for this fact and look at the efficiency (effect on poverty and inequality per dollar spent), pensions are not the leading program. It is in fact surpassed by different kinds of child support. Given that mothers in Belarus are allowed to take 3 years of unpaid maternity leave, which decreases household income, childcare benefits are relatively efficient.
The unexpected leader in efficiency is unemployment benefits, despite (or maybe due to) their negligible size. Shymanovich (2017) shows that unemployed face high risks of poverty, suggesting that an increase in the size of unemployment benefits and an easier access may bring huge benefits. The current minuscule size of the benefits (around $10-15 per month) is still enough to lift some people out of poverty, and has important equalizing effects, generating the biggest “bang for the buck” out of all benefits.
The student grants (stipends), the utilities subsidy and the transport subsidy have very low efficiency. These programs relocate a lot of funds to the upper deciles of the income distribution. Our calculations show that if all benefits, privileges and subsidies were not available to those in the top two income deciles, the Belarusian budget could save 1.4% of GDP.
Fiscal policies in Belarus are quite effective in redistributing income. Bornukova, Chubrik and Shymanovich (2017) show that the direct taxes and transfers in Belarus result in a decrease of poverty by 17 percentage points, and decrease the Gini coefficient of inequality from 0.41 to 0.27. The pension system has the most important contribution, decreasing poverty by 19 percentage points, and the Gini coefficient by 0.11.
However, the absence of a needs-based, well-targeted social support system leads to many inefficiencies. Direct and indirect taxes lead to impoverishment of 3.3% of population, which is not compensated by direct transfers.
The absence of targeting also leads to 1.4% of GDP redistributed towards the two upper income deciles through benefits, privileges and subsidies. This is, of course, highly inefficient. Better targeting could allow saving these funds or redirecting them to unemployment benefits – the most efficient but a very small benefits program so far.
- Bornukova, Kateryna, Alexander Chubrik and Gleb Shymanovich, 2017. “Fiscal Incidence in Belarus: a Commitment to Equity Analysis”, BEROC Working Paper Series, WP no. 42
- Chubrik, Alexander, 2007. “GDP Growth and Income Dynamics: Who Reaps the Benefits of Economic Growth in Belarus?” In Haiduk, K., Pelipas, I., Chubrik, A. (Eds.) Growth for All? Economy of Belarus: The Challenges Ahead; IPM research Center
- Lopez-Calva, L. F., Lustig, N., Matytsin, M., Popova, D., 2017. “Who Benefits from Fiscal Redistribution in Russia?”,in The Distributional Impact of Fiscal Policy: Experience from Developing Countries, edited by Gabriela Inchauste and Nora Lustig (Washington: World Bank, forthcoming).
- Gleb Shymanovich, 2017. “Poverty and Vulnerable Groups in Belarus: The Consequences of 2015-2016 Recession (in Russian)”, IPM Research Center Bulletin
- UNDP, 2016. “Regional Human Development Report 2016: Progress at Risk”, United Nations Development Programme, Istanbul Regional Hub, Regional Bureau for Europe and the CIS
There is a trade-off between two major objectives of a tax-benefit system: equity and efficiency. The tax-benefit systems that redistribute a lot of income tend to generate disincentives to work. The tax-benefit systems that create good incentives to work and earn, are less effective in mitigating poverty, social exclusion and deprivation. In this brief we argue that, when contrasted to other EU countries, the Latvian tax-benefit system is less effective in achieving either of the objectives.
There is a fundamental trade-off between the two principal objectives of a tax-benefit system – income redistribution and efficiency. On the one hand, income redistribution is desirable as it helps to mitigate socially undesirable market outcomes such as poverty and deprivation. On the other hand, more income redistribution is often associated with higher distortions to labour supply and work effort.
There is no universal prescription as to how much a government should redistribute. The answer to this question depends, among other factors, on the relative value that society (government) assigns to the welfare of different population groups, and on the individuals’ labour supply elasticity.
However, a given degree of income redistribution can be achieved at a different cost of efficiency. In this brief, we analyse the degree of income redistribution generated by the tax-benefit system and work incentives in Latvia in the context of other EU countries. In our analysis, we use the European microsimulation tax-benefit model EUROMOD (Sutherland and Figari, 2013) version G2.0, EU-SILC data, and the analysis framework developed by Jara and Tumino (2013).
Income Redistribution in the EU
EU countries differ substantially in terms of inequality of original income and in terms of the degree of redistribution generated by the tax-benefit system (see Figure 1, data on 2007 and 2013). The Gini coefficient of equivalised household original income (which consists of income from employment and self-employment, property income, private pensions, private transfers and other relatively minor components) ranges from around 0.4 (Cyprus, Netherlands) to almost 0.55 (Romania in 2007, Ireland in 2013).
Inequality of original income in Latvia in 2007 was at the EU average level (Gini coefficient of 0.47), but the degree of income redistribution generated by direct taxes, benefits and pensions was the lowest in the EU. As a result, the inequality of disposable income in Latvia in 2007 was the highest in the EU (Gini coefficient of 0.37). Part of the answer as to why the degree of income redistribution in Latvia is so low is a relatively small contribution of pensions to redistribution – it is almost half of that observed in the EU on average, despite the fact that the share of public pension recipients in the total Latvian population in 2007 was above the EU average. Another important factor was the very minor role of means-tested benefits: in the EU on average, means-tested benefits generate a reduction in Gini coefficient by about 0.02, while in Latvia the corresponding figure is just one tenth of this.
Figure 1. Gini coefficients of original equivalised household income and degree of redistribution generated by tax-benefit systems in the EU in 2007 and 2013
Source: EUROMOD statistics, authors’ calculations.
In the course of the crisis and the following recovery, the degree of redistribution in Latvia increased (see lower panel of Figure 1). An important factor behind the increase was growing number of pension recipients and an increase in the average size of pensions (both in absolute terms and relative to employment income). The increase in the number of pension recipients was not a result of changes in eligibility criteria, but was due to population ageing and the fact that more people applied for other types of pensions. The growth in the average size of pension was due to generous indexation of pensions in 2008 and compositional changes, as pensions of new pensioners until 2012 were larger than the average pension. Another reason for a growing degree of redistribution was an increase in the size and the number of recipients of means-tested benefits (mainly Guaranteed Minimum Income (GMI) benefit). This was a result of reforms in the provision of the means-tested benefits and of falling incomes from employment, which made more people eligible for the social assistance programmes. Nevertheless, despite the increase in recent years, the degree of income redistribution in Latvia remains one of the lowest in the EU.
The existence of a trade-off between income redistribution and better work incentives suggests that tax-benefit systems that ensure less income redistribution are likely to generate better work incentives. Jara and Tumino (2013) have demonstrated the existence of this trade-off in the EU countries in 2007-2010 by identifying a negative and statistically significant correlation between Gini coefficients and Marginal Effective Tax Rates (METR). The METR is a measure that is commonly used to quantify work incentives at the intensive margin. It shows what proportion of a small increase in earnings (which results from e.g. an increase in the supplied hours of work) is lost as a result of extra tax payments or foregone benefits that the person is no longer eligible for after the increase in earnings. The negative correlation identified in Jara and Tumino (2013) suggests that countries with less income redistribution (i.e., higher Gini coefficients) tend to have better work incentives (lower METRs).
In Latvia, the mean METR in 2013 was 32.2%, only slightly below the EU average (34.5%), and much higher than the average in Estonia (22.8%) and Lithuania (27.4%), despite a lower degree of income redistribution (EUROMOD statistics). Another feature of the Latvian tax-benefit system is that it is characterised by especially high METRs for poor individuals. Thus, in 2013, 94% of individuals who faced METRs in excess of 50% belonged to the two bottom deciles of distribution of equivalised disposable income. This is different from many other European countries, where distribution of high METRs is either more even across deciles or rising towards the top end of income distribution (Jara and Tumino (2013), data for 2007).
The main reason for high METRs faced by the poorest population groups in Latvia is the design of means-tested benefits (GMI and housing benefits), which generates 100% METRs for the recipients of these benefits. Namely, for each additional euro earned, the amount of benefit is reduced by one euro, which leaves the net income unchanged. This adversely affects employment incentives for the poorest individuals and increases the poverty risk.
Figure 2 illustrates mean METRs by deciles of equivalised disposable income in Latvia and shows the contribution of taxes, benefits and social insurance contributions (SICs) to the mean METRs. It clearly demonstrates that high METRs in the bottom deciles result mainly from the contribution of benefits, which disappears in the fourth decile. The contribution of SICs is slightly smaller in the bottom decile, which is due to the fact that the proportion of employed individuals is smaller in the bottom decile. For the same reason, and also because of basic tax allowances, the contribution of direct taxes is smaller in the bottom deciles, but then the contribution of taxes levels off, reflecting the Latvian flat tax rate.
Figure 2. The contribution of direct taxes, benefits and social insurance contributions (SIC) to METRs in Latvia by deciles of equivalised disposable income in 2013
Source: authors’ calculations using EUROMOD-LV
In their study on the incentive structure created by the tax and benefit system in Latvia, the World Bank (2013) pointed out the problem of bad work incentives generated by Latvian means-tested benefits. Our results, which are based on a population-representative database of incomes, also identify means-tested benefits as the major contributor to high METRs in the lowest deciles of the income distribution. Another concern expressed by the World Bank (2013) was that the problem of informal employment (either in the form of undeclared wages or work without a contract) can be exacerbated by high participation tax rates and METRs.
The Latvian tax-benefit system is characterized both by a relatively low degree of income redistribution and relatively weak work incentives, as measured by METRs. Recipients of means-tested benefits (GMI and housing benefits) are faced with 100% METRs, as benefits are withdrawn at the same rate as household income rises. This creates disincentives to increase labour supply for low-paid/low-skilled individuals, and hence creates a risk of poverty traps. Evidence from the literature suggests that the labour supply of low paid workers is particularly sensitive to the incentives generated by the tax-benefit system, hence reforms that would bring down METRs in the bottom deciles could yield positive results in terms of employment of low paid/low skilled workers.
A potential reform is to introduce either a gradual phasing out of the means-tested benefits, or to exclude a certain amount of employment income from the income test for the means-tested benefits. Such reforms would be targeted at the bottom end of the income distribution, help combat poverty, improve the incentive structure of the Latvian tax-benefit system, and positively affect the labour supply of low-skilled/low-paid workers.
- EUROMOD statistics on Distribution and Decomposition of Disposable Income, accessed at http://www.iser.essex.ac.uk/euromod/statistics/ using EUROMOD version no. G2.0, retrieved on October 14, 2014
- Jara, H. Xavier & Alberto Tumino (2013). “Tax-benefit systems, income distribution and work incentives in the European Union,” International Journal of Microsimulation, Interational Microsimulation Association, vol. 1(6), pages 27-62.
- Sutherland, Holly & Francesco Figari (2013). “EUROMOD: the European Union tax-benefit microsimulation model,” International Journal of Microsimulation, Interational Microsimulation Association, vol. 1(6), pages 4-26.
- World Bank (2013). “Latvia: “Who is Unemployed, Inactive or Needy? Assessing Post-Crisis Policy Options”. Analysis of the Incentive Structure Created by the Tax and Benefit System. Financial Incentives of the Tax and Benefit System in Latvia,” European Social Fund Activity “Complex support measures” No. 1DP//184.108.40.206.1./09/IPIA/NVA/001