Who benefits from the ‘hidden welfare state’? The distributional effects of personal income tax expenditure in six countries

Abstract:

We use a tax-benefit microsimulation model to investigate the size and distributional effects of tax allowances and tax credits in six European countries. Results indicate that tax allowances and tax credits benefit large sections of the population, not just individuals with high incomes and that together they amount to substantial amounts of foregone revenue.

However, with some (important) exceptions, their effect on inequality is small. Tax allowances are generally regressive while tax credits tend to be proportional or mildly progressive. Yet, the redistributive effect of tax allowances and tax credits works in complex and often unanticipated ways.

Other features of the income tax system (such as the tax rate schedule or the definition of the taxpayer unit) are as important in determining the size and direction of the redistributive effect as the characteristics of the tax allowances/tax credits themselves.

Even instruments inversely linked to taxable income can be more beneficial to high-income households in some contexts. Consequently, tax allowances and tax credits appear ill-suited to target resources towards households in the bottom part of the income distribution.