Impact of Taxes and Benefits on Inequality among Groups of Income Units

Abstract

This paper analyzes the redistributive impact of the fiscal system and simultaneously explains how each tax and benefit instrument satisfies the principles of vertical and horizontal equity within and across different groups of income units. The decompositions of the redistributive effect are based on new axioms concerning the vertical and horizontal equity of the overall fiscal system, including taxes and benefits. The method is based on pairwise comparisons of income units and the “micro” concepts of income supremacy change, deprivation from reranking, and income distance change. The decomposition results provide more detailed insights into the income redistribution process than is typical in the literature. This is illustrated by an empirical application of the method to the Croatian scheme of personal income taxes and non‐pension social benefits, in which households are divided into two groups, those with and those without children.