Abstract:
We analyse the effects of tax-based consolidations on income inequality, output and labour market conditions for a sample of 16 OECD countries over the period 1978-2012 employing a panel vector autoregressive methodology. We find that tax-based consolidations reduce income inequality, but at the cost of weaker economic activity. However, tax composition does matter. We show that indirect taxes reduce income inequality by more than direct taxes, possibly due to the operation of a positive labour supply channel. Among indirect taxes, value added and sale taxes are the most successful tool for policy-makers to balance efficiency and equity. Finally, we show that tax-based consolidations reduce disposable income inequality via a decrease in market income disparities and an increase in government redistribution respectively in countries with a weaker and a stronger preference for redistribution.