Might income inequality make structural adjustments more difficult?

The growing public debt in many nations has brought fiscal rebalancing to the top of policy agendas. This means raising taxes, or cutting expenditure. Recent US experience in the US and other nations suggest the presence of structural factors accounting for resistance to tax reforms.

One obstacle to tax changes may be polarised distribution of incomes.

If all agents are identical, equal burden sharing would be the norm;

With great income inequality, however, tax reforms usually get tangled in inequity debates, hindering, for example, efforts to broaden the tax base.

A mechanism explaining the resistance was proposed by Bénabou (2000). More inequality, he argues, may result in less government spending on redistribution because the consensus for ex ante efficient redistributive policies breaks down.

As a broader tax base is a necessary condition for greater redistribution, opponents of redistribution oppose broadening.

In this way, a high Gini coefficient could impair tax collection and thus reduce the fiscal space at a given public debt level.

This result was confirmed by the findings that more unequal societies do spend less on redistribution (de Mello and Tiongson 2006).

Overall, increased inequality, and thus decreased tax base and fiscal space, is associated with a significant worsening impact on sovereign risk, at least in the medium run. A one standard deviation increase of the Gini coefficient is associated with a rise of 470 basis points of the sovereign spread in 2011.

via Income inequality, tax base, and sovereign spreads | vox.