Tax Policy

The hypothesis that wealth inequality is driven by the higher returns earned by the rich—thereby offsetting the progressivity of the tax system—overlooks a key dimension: tax avoidance. Tax avoidance not only undermines the progressivity of the tax system but is also one of the reasons why the wealthy earn higher returns.

Why does the redistributing power of fiscal policy differ from country to country? I provide evidence that, although pre-tax and transfer income inequality tends to be similar across nations, post-fiscal intervention inequality varies significantly. I develop a general equilibrium model with heterogeneous agents, in which the degree of redistribution is determined endogenously. The findings reveal that the extent of redistribution is influenced by: (i) the size of economic shocks affecting the economy and (ii) the institutional rules under which fiscal policy is chosen. My model explains cross-country differences in fiscal policy’s distributional power.