Page 320 - Invited Paper Session (IPS) - Volume 2

IPS264 Oliver H. et al.
possible to replicate the actual tax system. This permits us to evaluate every
instrument of the fiscal welfare state (different taxes and deductions) with
regard to its impact on income inequality. We implement a Gini coefficient
based decomposition of redistributive effects by creating counterfactual
“what-if” scenarios that allow us to analyze the effect of taxes if the deductions
under scrutiny are included or excluded. While the main contribution of this
paper is to shed light on the hidden component of the fiscal welfare state -
deductions - the tax data at hand additionally provides us the opportunity to
gain insight into the sometimes subtle changes of tax systems over time and
how these changes affect the potential redistributive role of taxes. These
insights are based on comparing the results from 2011 to those of 2001.
During the intervening period, Switzerland experienced fierce tax competition
between the Swiss sub-states, the cantons, which resulted in financial relief for
high income earners.

2. The hidden welfare state
Deductions can be seen as an instrument of the fiscal welfare state that
aims to provide tax relief to specific groups. The OECD (2010) distinguishes
between distinct kinds of tax relief that have to be judged differently from a
perspective of redistribution:
 Tax exemptions: One possibility is to exclude incomes from taxation if
they fall below a certain threshold (e.g., incomes below the poverty
line).
 Privileged tax rates: e.g. for single parents.
 Tax credits: e.g. loss carryforward for self-employed persons.
 Tax deductions: either related to certain expenses (e.g., interest costs)
or standard deductions for predefined situations (e.g., child
deductions).
Regarding the redistributive impact of tax deductions, one must bear in
mind that their effect on post-tax income inequality is not direct but indirect.
Deductions alter taxable income and tax rates, but the actual effect on the
post-tax income distribution is complex and depends on the particular
constellation. Theoretically, three situations can be distinguished:
 Deductions are made equally across all income groups. As tax rates are
usually progressive, a flat deduction, however, over-proportionally
favors high income filers, thus leading to an increase in inequality.
 Deductions are more frequently used by high income filers. Therefore,
higher income taxpayers profit more and an increase in inequality is to
be expected.
 Deductions are over-proportionally used by lower income filers. In this
situation, inequality can decrease if the tax relief effect outweighs the
effect of lowered tax rates.

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