# **3. Income Redistribution: Vertical and Horizontal Equity**

Analyzing the equity dimension of a fiscal system should also assess how much horizontal inequity is generated by fiscal policy<sup>62</sup> . As discussed in Section III.2, the re-ranking definition of horizontal equity postulates that the prefiscal policy income ranking should be preserved. In other words, if individual A was poorer than individual B before an intervention, let’s say, cash transfers, but receives transfer benefits that makes A richer than individual B after the transfer, there is horizontal inequity or re-ranking.

In table 12, we show the RE, VE and RR effects for five middle-income countries with comparable data. Here the RE is measured by subtracting the Gini coefficient for post-fiscal income from the market income Gini; in other words, it is the change in inequality associated with direct and indirect taxes as well as direct transfers and subsidies. As one can observe, South Africa is the country that has both the highest redistributive effect and the lowest extent of horizontal inequity. Re-ranking as a proportion of the VE effect is significantly lower in South Africa (7.6 percent) than, for example, in Brazil (30 percent), the country with the second lowest ratio of RR/VE.<sup>63</sup> An extreme case of horizontal inequity induced by fiscal policy is Bolivia, where re-ranking completely wipes out the reduction in vertical inequity.

Table 12. Taxes, Transfer and Subsidies: Overall Redistributive Effect* <u>(Decline in Gini Points; shown as positive)</u>

||South<br>Africa<br>(2010)|Bolivia<br>(2009)|Brazil<br>(2009)|Indonesia<br>(2012)|
|---|---|---|---|---|
|Gini (Market income)|0.771|0.503|0.579|0.418|
|Gini (Post-fiscal income)|0.695|0.503|0.546|0.416|
|Redistributive Effect<sup>1</sup>|0.077|0.000|0.033|0.002|
|Vertical Equity (VE)<sup>2</sup>|0.083|0.003|0.048|0.007|
|Reranking Effect (RR)<sup>3</sup>|0.006|0.003|0.014|0.005|
|RR/VE|0.075|1.000|0.300|0.706|

<mark>Source: Lustig (forthcoming) based on:</mark> South Africa (income-based): Ingrid Woolard, Catriona Purfield, Mashekwa Maboshe (Master Workbook August 5, 2014) Bolivia (income-based): Paz Arauco, Verónica, George Gray Molina, Wilson Jiménez Pozo, and Ernesto Yáñez Aguilar (Master Workbook of CEQ-IDB project "Applying the Commitment to Equity (CEQ) Framework by Ethnicity and Race," July 18, 2014) Brazil (income-based): Sean Higgins and Claudiney Pereira (Master Workbook of CEQ-IDB project "Applying the Commitment to Equity (CEQ) Framework by Ethnicity and Race," July 18, 2014) Indonesia (consumption-based): Mathew Grant Wai-Poi, Jon Jellema, Rythia Afkar (Master Workbook CEQWorld Bank, May 28, 2014)

* Market income includes contributory pensions in all cases. Results with contributory pensions as government transfers are available upon request (except in South Africa, where social security pensions are not separately identified in the household survey).

1. Calculated as the difference between Market Income and Post-Fiscal Income Gini where Post-Fiscal Income includes the effects of Direct Taxes (PIT) and Social Security Contributions, Cash Transfers, Consumption subsidies and taxes.

2. Reynolds-Smolensky Index.

3. Atkinson-Plotnick Index.

4. From July 2009 to June 2010 NA: Not Available

> 62 See Duclos and Araar (2006), op. cit., Chapter 8.

> 63 One element that causes re-ranking in Brazil is the large Special Circumstances Pension, a social safety net program designed to assist households coping with adverse shocks (unemployment, illness, death, disability). The program is available regardless of poverty level of the household, and since the size of compensation is determined by the previous labor income of the household it can lead to larger transfers to non-poor families.

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