Inequality and Poverty Across Generations in the European Union

Abstract

The adverse consequences of inequality — social, economic, and political — have been increasingly recognized and under scrutiny. While global inequality has declined significantly over the past three decades, the evolution of inequality within countries is mixed. During the last decade, overall income inequality in the European Union (EU) has remained stable, but a closer look reveals that this reflected opposing developments between the real incomes of the young and the elderly. Before the global financial crisis, the young and the elderly had broadly similar risk of relative poverty in the EU. More recently, the risk of poverty increased significantly for the young and, to a lesser extent, for the rest of the working age population, while it declined sharply for the elderly. Labor market developments as well as the design of both social protection and fiscal consolidation likely contributed to this outcome. The crisis exacerbated preexisting high youth unemployment and a trend toward less stable jobs. High youth unemployment is associated with lower youth incomes and greater risk of youth poverty. Social protection systems are ill-equipped to address rising youth poverty. They shield the elderly’s real incomes from the impact of the crisis but offer only limited assistance to young unemployed individuals. Moreover, the latest fiscal consolidation efforts were more focused on programs helping the working age population rather than the elderly. High and prolonged youth unemployment and poverty have long-lasting effects on young people’s productivity and incomes, as well as their social prospects. The problems of youth unemployment and poverty are reaching macroeconomic proportions in several European economies. While the ongoing cyclical upturn improves job opportunities for the young, policymakers need to do more to ensure that today’s young do not fall further behind the rest of the population. To lower the chances of young people becoming poor and suffering lifetime income losses, facilitating their integration into the labor market is essential. To that effect, employers could be given incentives to hire young people, including through targeted reductions in the labor tax wedge or tax credits at the lower end of the wage scale. A better integration of the young into the labor market also requires improving and adapting their skills. Thus, spending on education and training needs to be protected from fiscal consolidation and its efficiency needs to be raised, including through better cooperation on the delivery of programs among employers, employee representatives, and governments. Better access to social protection systems for workers in less stable jobs could help preserve labor market flexibility, while significantly reducing youth poverty and income inequality. Policymakers could achieve this goal with reforms of unemployment and non-pension benefits. For example, eligibility requirements could be reviewed as well as the design, age targeting, and efficiency of transfers. A more uniform approach to indexation across benefits could also help along with, more generally, better consideration of the distributional impact across age groups of public expenditure policy. Finally, tax reform could rebalance the tax burden across generations and increase the redistributive impact of taxation, by increasing progressivity on income taxes and by giving a greater redistributive role to taxes on capital income and wealth.