metadata: authors: 0: author: Goraus Tanska,Karolina Marta
1: author: Inchauste Comboni,Maria Gabriela
count: Poland
docna: 0: docna: The distributional impact of taxes and
            transfers in Poland
docty: Policy Research Working Paper
subtopic: Health Care Services Industry,Disability,Educational Sciences,Social Development & Poverty,Inequality
abstracts: cdata!: This paper assesses the impact of fiscal
            policy on the incidence, depth, and severity of poverty, and
            examines whether there is room for an increased role for
            fiscal policy in improving the wellbeing of the poor. The
            results show that the combined effect of taxes and social
            spending helped substantially to reduce poverty and
            inequality in Poland in 2014, in line with other European
            Union countries, with most of the reduction largely being
            achieved by pensions. However, in cash terms, households
            beginning in the second decile were net payers to the
            treasury in 2014, as the share of taxes paid exceeded the
            cash benefits received for all but the poorest 10 percent of
            the population. Although the Polish fiscal system in 2014
            had the capacity to redistribute, it had a relatively weak
            capacity to reduce poverty given the resources at its
            disposal, and this was especially true for families with
            children. Microsimulations of the introduction of the Family
            500  program in 2016 show the redistributive and poverty
            reduction impacts of the new program, even after taking into
            account the potential increase in indirect taxes. Finally,
            alternative reforms of the tax-free allowance are
            considered, and estimates of their likely impact on poverty,
            inequality, and the potential fiscal cost are presented. The
            simulations show that there are potential efficiency gains
            from further targeting each of these new initiatives.
geo_reg_key: 517191,517208
repnme: repnme: The distributional impact of taxes and
            transfers in Poland
display_title: The distributional impact of taxes
            and transfers in Poland
listing_relative_url: /research/2016/08/26676444/distributional-impact-taxes-transfers-poland
topicv3: Poverty m1326687 695,Social Insurance m1326950 751,Education m1327048 470,Health m1504661 3480,Disability m1583873 4215
publishtoextweb_dt: 2016-08-09T00:00:00Z
no_of_pages: 52
author_keys: 0: author_key: 1243429
1: author_key: 1130122
model_extractions: WPS7787 Policy Research Working Paper 7787 The Distributional Impact of Taxes and Transfers in Poland _Karolina Goraus Gabriela Inchauste_ Poverty and Equity Global Practice Group August 2016
Policy Research Working Paper 7787

# **Abstract**

This paper assesses the impact of fiscal policy on the incidence, depth, and severity of poverty, and examines whether there is room for an increased role for fiscal policy in improving the wellbeing of the poor. The results show that the combined effect of taxes and social spending helped substantially to reduce poverty and inequality in Poland in 2014, in line with other European Union countries, with most of the reduction largely being achieved by pensions. However, in cash terms, households beginning in the second decile were net payers to the treasury in 2014, as the share of taxes paid exceeded the cash benefits received for all but the poorest 10 percent of the population. Although the Polish fiscal system in 2014 had the capacity to redistribute, it had a relatively weak capacity to reduce poverty given the resources at its disposal, and this was especially true for families with children. Microsimulations of the introduction of the Family 500+ program in 2016 show the redistributive and poverty reduction impacts of the new program, even after taking into account the potential increase in indirect taxes. Finally, alternative reforms of the tax-free allowance are considered, and estimates of their likely impact on poverty, inequality, and the potential fiscal cost are presented. The simulations show that there are potential efficiency gains from further targeting each of these new initiatives.

This paper is a product of the Poverty and Equity Global Practice Group. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The authors may be contacted at ginchauste@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# **The Distributional Impact of Taxes and Transfers in Poland**

Karolina Goraus and Gabriela Inchauste<sup>1</sup> JEL classification: H22, I38, D31 Keywords: fiscal policy, fiscal incidence, social spending, inequality, poverty, taxes, Poland

> 1 We are deeply indebted to Michał Myck and Mateusz Najsztub for guidance and support in building a microsimulation model for Poland. We are also grateful to Emilia Skrok, Cristobal Ridao-Cano and Leszek Kąsek for helpful comments and advice. All remaining errors are our own.
# **I. Introduction**

There has been substantial work in better understanding the role of fiscal policy in Poland. Some of the highlights are work looking at the labor incentive effects of tax reforms (Morawski and Myck, 2010; Myck et al, 2013) and analyzing the combined effect of direct taxes, pensions, social security contributions, and social benefits (De Agostini et al 2014; Paulus, 2015; Brzeziński, 2015). There are well known country-level microsimulation models using the Household Budget Survey that have separately undertaken microsimulation analysis of specific reforms including changes in family benefits (Myck 2015a); Value Added Taxes (Myck, 2015b); and others. Existing work has shown the dominant role of pensions in overall incidence (Paulus, 2015) and the relatively small role of policy in reducing inequality (Myck and Najsztub, forthcoming).

Despite the large literature on the tax-benefit system in Poland, most of the existing analysis that has aimed to combine the impacts of taxes and spending has not included indirect taxation in the overall analysis, despite the fact that it makes up about half of total tax collections. Similarly, most studies have not included the impact of spending on education and health, despite the fact that they make up more than a third of total social spending and are an important component in terms of improving equality of opportunities across the population.

This paper aims to present a more comprehensive analysis of the impact of fiscal policy on inequality and poverty in Poland relative to earlier studies. Building on existing work done in Poland, the analysis covers the impact of the contributory pension system, direct taxes and transfers, the impact of value added and excise taxes, as well as the impact of education and health spending. The analysis assesses the progressiveness of each fiscal instrument and its contribution to reducing poverty and inequality. The approach follows the Commitment to Equity (CEQ) methodology (Lustig and Higgins, 2013), allowing comparisons between Poland with other countries where the CEQ methodology has been applied.<sup>2</sup> The analysis is built on the 2014 Polish Household Budget Survey (HBS) collected by the Central Statistical Office of Poland (GUS), and data from National Income Accounts and public finance accounts from the Ministry of Finance for 2014. Although most of the analysis follows a partial equilibrium approach, we use the 2010 input-output matrix is used to capture the second-round effects of excise taxes on intermediate goods, such as fuel, since these can be important as they are passed through to prices of all other goods. In terms of coverage of components of fiscal policy, the analysis includes 62 percent of tax revenue and 51 percent of government spending, in line with other CEQ studies. The analysis does not cover the corporate profit tax and VAT paid by government or institutional consumption as these are difficult to assign to individual households

> 2 For more details, see <u>http://www.commitmentoequity.org .</u>

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based on the available information. On the spending side, the analysis only covers social spending, as it is very difficult to assign benefits of other types of spending to individual households.

The analysis finds that the combined effect of taxes and social spending help to substantially reduce inequality in Poland, in line with other EU countries, with most of the reduction in poverty and inequality largely being achieved by pensions. Inequality is further reduced by in-kind transfers in the form of education and health. However, we find that in cash terms, households beginning in the second decile were net payers to the treasury in 2014, as the share of taxes paid exceeded the cash benefits received for all but the poorest 10 percent of the population.

In terms of the specific fiscal interventions, we find that most direct taxes are progressive and equalizing with the exception of agricultural taxes and farmer contributions, which depend on land size rather than on income generation. However, we also find that direct taxes and contributions are also poverty increasing to the extent that most contributions do not have a minimum threshold, thus posing a large burden on poor households. Moreover, indirect taxes are regressive and contribute to poverty and inequality increases. Direct transfers are progressive and equalizing, particularly family benefit and social assistance programs, which are pro-poor. Contributory benefit programs make up a large share of the incomes of the poor, but they are not pro-poor. Finally, spending on health and education is progressive and equalizing.

Overall, the Polish fiscal system in 2014 had the capacity to redistribute, but a relatively weak capacity to reduce poverty given the amount of resources at its disposal, particularly for families with children. Microsimulations show that the recent introduction of the Family 500+ program has already made an important change in this respect, potentially leading to a 3 percentage point reduction in extreme poverty and a strong redistributive impact of the system as a whole. The cost of the program is estimated to amount to 1.3 percent of GDP, once projected increases in indirect tax collections are taken into account. Similarly, proposals to extend the tax-free amount are expected to make the personal income tax more progressive and further improve the redistributive impact of fiscal policy. However, the change is expected to be much smaller than that of the Family 500+ as the benefits are expected to be more heavily concentrated at the top of the distribution. The fiscal cost of the proposed tax-free allowance reform is estimated to amount to an additional 0.4 to 1.1 percent of GDP, depending on the threshold that is decided. The simulations show that there are potential efficiency gains from further targeting each of these new initiatives. Going forward, it will be important to consider how these initiatives will be financed, and the potential distributional impact of measures needed to ensure that the government is able to keep to its deficit rule.

The rest of the paper is organized as follows. The next section describes the structure of taxes and social spending in Poland, followed by the general methodology, the data used and assumptions made in estimating the taxes paid by households and the benefits received. Section IV describes the overall impact of fiscal policy on poverty and inequality. The incidence of taxes and spending 3
are presented in section V, followed by simulations of the Family 500+ program and alternative scenarios on the tax-free allowance in section VI. Section VII concludes.

# **II. The structure of taxes and social spending in Poland: 2014**

## **The Polish Public Finance System**

Public finance in Poland consists of local governments, a social insurance sector and the central government. Obligations to pay taxes and contributions are largely unified and collected within a centralized system with few regional and local taxes. Direct taxes are shared between central and local governments, while social insurance contributions fund the Social Insurance Institution (ZUS), the Social Insurance Institution for Farmers (KRUS), the Labor Fund, the Fund of Guaranteed Employees’ Benefits, the National Rehabilitation Fund, and the National Health Fund (NFZ). According to internationally comparable definition total revenues amounted to 667.7 billion PLN (38.8 percent of GDP) in 2014, of which 19.8 percent came from tax collections, and 13.2 percent were social security contributions.<sup>3</sup> The structure of tax revenues in Poland is shown in Table 1.

Indirect taxes contribute about 54 percent of the total tax collection of the general government, with the bulk of indirect taxes collected from VAT (Table 1). Our analysis focused on the major tax items, namely social security and health insurance contributions, personal income tax, valueadded tax, and specific excise duties on alcohol, tobacco, automobiles and fuel. These items make up about 62 percent of all tax revenue in 2014. Corporate taxes were not included given the difficulty of attributing the tax burden to specific households.

## **_Direct taxes and social insurance contributions_**

Personal income tax (PIT) revenues accounted for 4.6 percent of GDP in 2014. There are two rates of PIT, 18% and 32%, with the threshold for the first rate set at PLN 85,528 (US$21,919) of annual individual global income (Table 2). Couples or single parents may file jointly, with their income base added and then the tax is calculated from half of this amount and doubled.<sup>4</sup> PIT does not apply

> 3 The internationally comparable definition of General Government excludes R&D institutions or Agricultural Market Agency that are included in the national definition, and includes Open Pension Funds that are excluded by the national definition.

> 4 In this way the tax liability is lower if: (1) one of the income earners is below the threshold for second PIT rate, and the other is above, as part of the income of the high earning partner will be taxed with 18% rate instead 32% rate, (2) one of the partners is earning so little that is not using tax allowance then the spouse can use both tax allowances.

4
to agricultural income or social security contributions paid by the employee. Self-employed income can either be included in the global income or taxed separately at the flat rate of 19%.<sup>5</sup>

**Table 1. Poland: Tax Revenue Structure 2014**

||Fiscal data<br>(Million<br>PLN)|% of<br>GDP|Included<br>in<br>analysis|Derived<br>in<br>survey<br>(Million<br>PLN)|Ratio of total<br>amounts in the<br>survey and<br>external<br>statistics, %|
|---|---|---|---|---|---|
|**Total revenue**|667,698|38.8||398,917|60%|
|Total tax receipts|339,851|19.8||119,416|35%|
|_Direct taxes_|108,657|6.3||45,840|42%|
|Personal income tax|78,617|4.6||45,840|42%|
|Employees & self-employed paying 18% or 32%|55,567|3.2|Yes|43,293|55%|
|Self-employed who choose 19% flat tax|16,972|1|No|||
|Capital tax|836|0.0|Yes|67|8%|
|Agricultural tax|2,090|0.1|Yes|2,479|119%|
|Other income taxes on households|3,152|0.2|No|||
|Corporate profit tax|30,040|1.7|No|||
|_Indirect taxes_|185,833|10.8||73,576|40%|
|VAT|124,262|7.2||54,833|44%|
|from household consumption 1/|83,043|4.8|Yes|54,833|66%|
|from other consumption|41,219|2.4|No|||
|Excise duties and consumption taxes|61,570|3.6|Yes|18,743|30%|
|_Other taxes_|45,361<br>|2.6|No|||
|Net social contributions|227,548|13.2||205,926|90%|
|Old-age pension contribution|121608|71|Yes|86,164|100%|
|Disability pension contribution|,|.|Yes|35,313||
|Accident insurance contribution|6,212<br>|0.4|Yes|8,540|137%|
|Sickness insurance contribution|10,849<br>|0.6|Yes|9,593|88%|
|Labor Fund|9,569<br>|0.6|Yes|10,841|113%|
|Fund of Guaranteed Employee Benefits|390<br>|0.0|Yes|392|100%|
|Farmers old-age and disability contribution|1,518<br>|0.1|Yes|1,503|99%|
|Farmers other contributions|701<br>|0.0|Yes|713|102%|
|Health insurance contributions|61,204|3.6|Yes|52,869|86%|
|Other contributions|15,496<br>|0.9|No|||
|Other revenue<br>Sources: Eurostat, GUS, and own estimates based on HBS 20<br>1/ We assume that the share of VAT paid by households is e<br>consumption according National Accounts and total gross v|100,299<br>14.<br>quivalent to t<br>alue added in|5.8<br>he ratio<br>the econ|No<br>between to<br>omy.|tal house|hold|

Similarly, capital gains and investment income, such as dividends, interest and proceeds from sale of shares, are subject to withholding tax at a flat rate of 19%. Income from renting property can be either included in global income, or individuals can choose the flat tax on revenues of 8.5%. Households can deduct costs of obtaining income, a basic tax-free allowance of PLN 3,000 per

> 5 If a self-employed person decides to use the flat tax, they may not file jointly with their spouse or deduct child tax credit.

5
year, and health insurance contributions (see below). If health insurance contributions are higher than the pre-health insurance deduction personal income tax, then the health contribution value is decreased to the level of PIT. Finally, there are other important deductions, including a child tax credit, deductions for internet bill payments, and rehabilitation expenses among others. The most significant of these is the child tax credit (CTC), which cannot exceed the pre-CTC PIT value plus social security and health contributions paid.

**Table 2. Poland: Tax and Social Security Contributions**

|Main taxes applicabletoindividualsin Pol|and|||
|---|---|---|---|
|Personal income tax - regular rates||18% and 32%(for incom|e > PLN 85,528)|
|Personal income tax – flat rate (may be app<br>employment ifcertainconditions aremet)|lied to self-|19%||
|Dividends||19%||
|Interest||19%||
|Royalties||18% and 32%||
|Capitalgains||19%||
|VAT||23% (standard rate), red<br>along withsome exempt|uced rates of 8%, 5%, 0%<br>ions.|
|Inheritance tax||3%-20%||
|Special expatriate regime (only selected so<br>income)|urces of|20%||
|Social insurance contributions||||
|Insurance type|Cap on salary<br>|Allocation o|f contribution cost|
||subject to|||
||contribution|Employer|Employee|
|Pension|112,380 PLN|9.76% of remuneration|9.76% of remuneration|
|Disability|per annum|6.5% of remuneration|1.5% of remuneration|
|Sickness||-|2.45% of remuneration|
|Accident|No cap<br>applies|0.67% - 3.33% of<br>remuneration<br>(depending on risk<br>category). 1.67% is the<br>mostcommon rate||
|Health||-|9% (7,75% taxdeductible)|
|Otheremployer’s charges||||
|Labor Fund||2.45% of remuneration||
|Employees’GuaranteedPaymentsFund||0.1% of remuneration||
|Source: Deloitte (2015).||||

Agricultural taxes are levied on ownership or possession of agricultural arable lands or woods. In case of farm land the taxable base is the number of conversion hectares (calculated on the basis of actual area, kind and quality of land and location in one of four tax zones, set depending on 6
economic and climatic conditions of agricultural production). For other land the taxable base is the number of hectares.

Social insurance contributions (SIC) are the largest source of revenues, accounting for 13.2 percent of GDP in 2014. These contributions include old-age, disability, accident and illness insurance contributions, some of which are shared between employee and employer as shown in Table 2. In terms of old-age pensions, Poland has a three-pillar pension system in place, under which both the employee and the employer make contributions to the first and second pillars. Employees can make voluntary payments to third-pillar funds, usually managed by insurers or banks. Fiscal incentives in the third pillar have been created to encourage employees and employers to set up retirement plans.

Note that social security contributions differ depending on the type of employment arrangement: self-employed workers and farmers pay lump-sum amounts based on the average wage<sup>6</sup> and land size, respectively, while dependent employees’ contributions are a function of their wages. Moreover, dependent workers with Labor Code contracts have contributions paid from the total amount of their gross wage, while employees with Civil Code contracts (both those under commission contracts and those with contracts for results) do not. In particular employees hired under civil law contracts for results have no insurance, while those hired under commission contracts have health insurance contributions paid from total gross income but voluntary contributions for other social insurance schemes,<sup>7</sup> so that civil-contract employees could effectively pay close to zero social security contributions in 2014. Recent changes that became effective in 2016 aimed to limit this practice, but continue to be voluntary for illness insurance.

Mandatory health insurance contributions cover preventive, diagnostic, therapeutic, and rehabilitation costs. Nearly all social groups are covered, giving them access to health protection, disease and contusions prevention, early detection of illnesses as well as disability prevention. In case of dependent employment health insurance is calculated as 9% of gross wage minus social security contributions paid by employee. Health contributions apply to labor and commission contracts, but not to contracts for results. Health contributions are also paid from maternity leave benefit, unemployment benefit, old-age pension, disability pension, family pension, pre-retirement benefit, and social pension on terms similar to wage employment income. Self-employed workers contribute according to a fixed schedule.

> 6 Minimum wages are used for those operating less than two years.

> 7 Persons working on commission contracts had to contribute based on the first contract alone but contributions for subsequent contracts were voluntary. As a result, employers often signed two contracts with the same worker, one for a very low value, and other of the actual value of work. The contributions were paid from the low-value contract, thus enabling workers to pay (close to) zero contributions.

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# **_Indirect Taxes_**

VAT is a major component of indirect taxes, contributing to about 36 percent of total tax collection in 2014. VAT is levied at a standard rate of 23 percent on most goods and services, but a reduced rate of 5 percent applies to certain food, books and magazines or 8 percent is imposed on supplies, such as medicines, hotel and catering services, certain transport and municipal services. There exists also a rate of 7% for products bought from farmers who pay the tax as a lump sum. A zero-rate applies to the intra-EU community supply of goods, exports of goods, some international transportation and related services. Usually, in order to apply zero VAT rate additional conditions need to be fulfilled. Some financial, medical and cultural services are exempt. In particular, small entrepreneurs with yearly revenues below 150 thousand zloty, are exempt from paying VAT and may not deduct the VAT paid on inputs. The VAT gap has been estimated to be between 30% and 50% of VAT collected (PwC, 2013).

Excise taxes contribute 3.4 percent of GDP and they are levied on goods that are deemed to be a harmful for health reasons. The Ministry of Finance in Poland announces every year the excise taxes that apply to products that might be harmful to health or environment. Goods subject to excise duty include energy products, alcoholic beverages and manufactured tobacco products, based on the legislation of the European Union.

# **Social spending**

Overall expenditures in Poland amounted to 42.1 percent of GDP in 2014, down from 45.5 percent of GDP in 2010 (Eurostat). A large part of public spending is dedicated to social protection (16.1 percent of GDP), while education (5.3 percent of GDP) and health (4.6 percent of GDP) are also relatively important. Total social spending in Poland amounts to 26 percent of GDP or 62 percent of total spending. The analysis presented below covers 51 percent of all government spending and 82 percent of social spending. In what follows, we describe the main highlights of existing social spending.

Spending on contributory pensions at 15.3 percent of GDP in 2014, accounts for the bulk of the social protection system. These benefits include old-age pensions which are by far the largest. In addition, there are several insurance schemes that deliver benefits, including disability and survivor pensions, maternity and unemployment benefits, as well as sickness allowances, funeral grants, family care, occupational and health rehabilitation allowances for insured individuals. In contrast, the non-contributory portion of the social protection system, accounts for only 0.9 percent of GDP in 2014 (Table 3). This figure includes spending on direct cash and near-cash transfers and can be thought of having three main pillars: family benefits, housing benefits, and social assistance.

8
**Table 3: Poland: General Government Expenditure 2014**

|Spending Component|Millions of<br>PLN|% of<br>GDP|Included in<br>analysis|<br>Amounts in<br>survey|Ratio of total<br>amounts in the<br>survey and external<br>statistics,%|
|---|---|---|---|---|---|
|Total expenditures|724,465|42.1||367,516|51%|
|Social Spending|447,164|26.0||367,516|82%|
|_Social Protection_|276,949|16.1||207,823|75%|
|Contributory social insurance benefits|216,511|12.6||192,439|89%|
|Old age|148,859|8.7|||0%|
|Gross retirement pension|133,049|7.7|Yes|145,682|109%|
|Gross pre-retirement pension|2,370|0.1|Yes|2,203|93%|
|Structural (farmer) pension|13,440|0.8|Yes|1,544|11%|
|Other pensions|67,652|3.9|||0%|
|Gross family pension|29,668|1.7|Yes|16,834|57%|
|Gross disability pension|20,277|1.2|Yes|15,581|77%|
|Gross maternity benefit|6,736|0.4|Yes|6,975|104%|
|Gross unemployment benefit|9,692|0.6|Yes|3,620|37%|
|Gross rehabilitation benefits|1,279|0.1|Yes|605|47%|
|Non-contributory (social assistance) benefits|14,656|0.9||15,384|105%|
|Social assistance|1,859|0.1|Yes|2,590|139%|
|Social pension|2,267|0.1|Yes|5,154|227%|
|Family benefits|5,152|0.3|Yes|3,517|68%|
|Child birth grant in monthly terms|279|0.0|Yes|4|1%|
|Nursing Benefit (zasiłek)|1,702|0.1|Yes|1,115|66%|
|Nursing Allowance (świadczenie)|929|0.1|Yes|2,010|216%|
|Alimony fund maintenance income|1,497|0.1|Yes|||
|Housing benefits|971|0.1|Yes|995|102%|
|Other|45,781|2.7|No|||
|_In-kind transfers_|170,216<br>|9.9||159,694|94%|
|_Education_|90,482|5.3|Yes|96,495|107%|
|Kindergarten subsidy|||Yes|6,772||
|Primary school subsidy|||Yes|32,879||
|Primary school (disability) subsidy|||Yes|4,011||
|Gymnasium|||Yes|16,778||
|Gymnasion (disability)|61,243|3.6|Yes|1,361||
|High school|||Yes|5,354||
|High school (disability)|||Yes|621||
|Vocational school|||Yes|7,629||
|Vocational school (disability)|||Yes|1,688||
|Tertiary schools|14,477|0.8|Yes|19,403|134%|
|Other education|14,761|0.9|No|||
|_Healthcare_|79,734|4.6|Yes|63,199|79%|
|Health insurance fund|61,653|3.6|No|||
|Other health|18,081|1.1||||
|_Other social spending_||||||
|Other expenditure(non-social)|277,301|16.1||||

Sources: Eurostat, GUS, and own estimates based on HBS 2014.

9
Direct (non-contributory) transfers include the following programs.

- _Family benefits programs,_ target low-income families with children (World Bank, 2015; De Agostini et al, 2015). The main component is a non-contributory means tested monthly grant to families that have dependent children called the Family Allowance. The Family Allowance is paid until the child finishes their education. In addition, the following supplements may also be granted: a one-time lump sum grant paid upon the birth of a child, supplements for parental leave, lone parents who do not receive alimony payments, education and rehabilitation of a disabled child, a supplement for the third and each subsequent child, a supplement for the start of the school year, and for starting school outside the place of residence. There is also a nursing benefit for disabled persons and a nursing allowance for a parent or guardian who resigns from employment or other paid job in order to take care of a disabled child.

- _Housing benefits_ are means tested benefits granted to families based on the size of their home and number of people in the household.

- _Social assistance programs_ include a non-contributory benefit for households that have insufficient resources while also meeting some specific social criteria (De Agostini et al, 2015). It is intended to benefit orphans, the disabled, unemployed, homeless, the chronically sick, pregnant women and those generally in poverty. There is a social pension, which provides compensation to individuals who are completely incapable to work due to an impairment of bodily functions which occurred before finalizing their education. In addition, there are three main Social Assistance programs: (i)  a Permanent Compensation Benefit granted to a person who is unable to work due to disability or age and who does not qualify for social insurance or disability pensions; (ii) a Temporary Social Benefit granted to households with incomes below a given threshold experiencing financial problems caused by unemployment, prolonged illness or disability and (iii) a Special Purpose Benefit paid in case of unforeseen events like natural disasters.

Social spending on in-kind transfers in the form of education and health amounted to 9.9 percent of GDP in 2014. Kindergartens, primary schools, gymnasium, high schools and vocational schools are financed by local governments partly based on a central government educational subsidy based on the number of pupils, as well as based on their own resources. Although educational institutions are mainly public, where no required user fees are required, around 4% of primary schools, gymnasiums, or high schools students attend private schools. These private schools also receive subsidies from local governments based on spending per child in each level of public educational institution. The share of privately operated institutions is higher when it comes to kindergartens, covering around 40% of children attending kindergartens. For the kindergartens the subsidy per child for private institutions should be at least 75% of spending per child in public institutions. Tertiary education is subsidized by the central government, with public universities receiving a teaching subsidy based on the number of stationary students, which accounts for about 70% of their total revenue.

10
Health services are provided through the National Health Fund (NFZ), which is financed from health contributions. NFZ contracts health service providers and reimburses the cost of services provided to insured clients. The Ministry of Health directly funds a few highly specialized services along with pre-hospital emergency services. Contributions to the public system are mandatory for all classes of workers except those on pay-for-performance civil contracts, so most workers are covered, either directly or through family since anyone with uninsured family members can insure them. Persons receiving contributory benefits like pensions or unemployment benefits are also covered. In addition, an uninsured person without insured family members may have the right to health services financed from public money if they are: (a) below the age of 18, (b) pregnant or in the period of confinement, or (c) have income below the legal poverty threshold. In practice, only non-poor individuals who do not pay voluntary health insurance contributions are uninsured and would have to bear the cost of health services. Private insurance is available and is usually provided as a top-up to public health insurance, with people opting-out from publically provided services for primary or dental care, as well as some in-patient curative services.

# **III. Data sources, method, and assumptions**

## **Data Sources**

Data for 2014 were used to conduct this incidence analysis study in line with the availability of survey data. Specifically, we used the 2014 Poland Household Budget Survey (PHBS) by the Central Statistical Office of Poland (GUS). In contrast to the EU SILC, the PHBS contains both income and expenditure data, along with demographic and household characteristics, thus enabling the identification of direct and indirect taxes and benefits across the distribution. Following standard practice, the collected survey is corrected for nonresponse through sample grossing-up weights. However, these weights take into account and correct only for the original data sample design probabilities and do not reflect the additional bias in survey participation given the characteristics of participating households. For example, the survey over-represents children in the survey and people who live abroad for more than 12 months, so that the age structure does not match that of the census. In order to match the age structure of the population along with critical characteristics of the tax and benefit system, we follow Myck and Najsztub (2015) to correct population weights in the PHBS.<sup>8</sup> Household survey data are combined with data from GUS Statistical Yearbooks, National Income Accounts and public finance accounts from the Ministry of Finance. This information is complemented with administrative data from the Social Insurance Institution (ZUS), National

> 8 In particular, in addition to correcting for the age structure, weights are calibrated to ensure that the number of taxpayers, those paying health insurance, receiving pensions, unemployment benefits, and those benefiting from joint taxation are in line with administrative data.

11
Health Service (NFZ), Ministry of Family, Labor and Social Policy (MRPiPS), Ministry of Health, and Ministry of Education. Finally, we use the 2010 Input-Output matrix to estimate the indirect effect of indirect taxes as described below and detailed in Appendix I.

# **Method and Approach**

To analyze the incidence of each fiscal intervention, and the impact of taxes and social spending on poverty and inequality, we follow Lustig and Higgins (2013) and measure per capita income before and after each fiscal intervention as described in Figure 1. In particular, for every household we define the following income concepts:

- _Market income_ includes pre-tax wages, salaries, and income earned from capital assets (rent, interest or dividends) and private transfers.

- _Disposable income_ is constructed by subtracting direct taxes and social contributions and adding direct transfers and social pensions to market income. Direct taxes include the personal income tax, capital tax, and farm taxes. Social contributions include those for disability and farmer pensions, health, accident and sickness insurance, as well as contributions to the labor fund, the fund of employee benefits, and to other farmer benefits. Direct cash transfers include housing benefits, child birth grant, nursing benefit, nursing allowance, social assistance, and family benefits. In addition, there are pre-retirement, family, disability, maternity, unemployment and farmer pensions which are treated as transfers.

- _Consumable income_ subtracts the impact of indirect taxes to disposable income. In Poland, indirect taxes included in this analysis include the VAT, excises on alcohol and tobacco, fuel and automobiles.

- _Final income_ adds in-kind benefits in the form of health and education to consumable income.

One area where there is no clear consensus in the literature is on how to treat contributory pensions and the related contributions. Arguments exist in favor of treating contributory pensions as individual savings or deferred income, while others argue that they should be treated as a government transfer, with the related contributions being treated as a direct tax. Following Lustig and Higgins, we present two scenarios. Under our “main” scenario all contributory pensions are treated as transfers, and the corresponding contributions are treated as taxes and therefore subtracted from disposable income, in line with standard EU measurement of disposable income. Under the “alternative” scenario, old-age contributory pensions are treated as deferred income, and the corresponding old-age contributions are treated as savings, and thus as part of disposable income.<sup>9</sup>

> 9 All other pensions are treated as transfers and the corresponding contributions as taxes under the alternative scenario. One could argue that there is some double counting under the alternative scenario, as pensions are included

12
<!-- Start of picture text --> Transfersfr Wagesoy and salaries,Market. *income Incomefrom capital,* private. Taxes<br>transfers; before government taxes, social<br>security contributions and transfers.<br>- Personal income taxes and<br>+<br>Direct transfers ; employee contributions to<br>Disposable Income<br>+<br><!-- End of picture text --> <!-- Start of picture text --> Indirect subsidies ; re<br>Indirect taxes<br>Consumable Income<br>In-kind transfers (free or +<br>subsidized government services . ~<br>in education and health) Co-payments, user fees<br><!-- End of picture text -->
for which VAT rates are defined.<sup>10</sup> Note that as in most household surveys, total consumption of households in HBS using the weights provided by GUS amount to 49 percent of total household consumption reported in National Accounts. Since we do not make assumptions about informality, the amount of VAT calculated using the HBS constitutes 67 percent of total tax collections paid by the households. For excise taxes, we apply statutory rates to consumption of alcohol, tobacco, fuel and automobiles (net of VAT) identified in the HBS to estimate the direct burden of these excises on households. However, since fuel is an important intermediate product we use a costpush model and the 2010 input-output matrix to estimate second round effects of excises on fuel to all other products in the economy.

On the spending side, the HBS provides detailed information on who received payment from contributory and non-contributory social protection programs. Family Allowance, Social Assistance, Nursing Allowance, Nursing Benefit, and Housing Benefit are directly identified in the survey and since they are not taxable, the reported net value can be directly used.

The approach to estimate the incidence of public spending on education followed here is the socalled “benefit or expenditure incidence” or the “government cost” approach. In essence, we calculate per beneficiary input costs by level of education from government spending at the voivodship level and the number of pupils in each level and voivodship. This approach is also known as the “classic” or “non-behavioral approach”, and it amounts to asking the following question: how much would the income of a household have to be increased if it had to pay for the free or subsidized public service at the full cost to the government? Since the HBS does not provide information on educational enrolment by public versus private institutions, we identify children going to public schools based on household expenditures on tuition, and assign a lower public benefit to those households based on the standard subsidy amount per student in private institution (75 percent for those in private kindergartens, and 50 percent in other school types). For university students we calculate the share of public university subsidy per stationary student and assign this amount to students assumed to be attending public universities based on HBS data.

Finally, for health we use the cost of insurance approach and assign a per capita benefit to all individuals. However, some households opt out of public service and pay for private insurance to cover primary care, dental services, outpatient care, and rehabilitation, as identified in the HBS. For these households, we reduce the public benefit amount accordingly.

There are some important caveats about what the fiscal incidence analysis applied here does not address. First, it does not take into account behavioral, lifecycle or general equilibrium effects and focuses on average incidence rather than incidence at the margin. Our tax shifting and labor supply responses assumptions are strong because they imply that that consumers have perfectly inelastic

> 10 Note that we do not apply statutory VAT or excise rates to expenditures related to farming activities as we treat those as intermediate products.

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demand and that labor supply is perfectly inelastic too. Second, the analysis does not take into account the intra-household distribution of consumption. Third, the analysis cannot take into account the quality of services delivered by the government. In addition, we are unable to include some important taxes and spending. Corporate profit taxes, VAT paid by government or institutional consumption, and spending on infrastructure investments are excluded, even though the impacts of these may be substantial simply because the methods to assign these taxes and transfers are not robust. Finally, the analysis does not capture the growing debate on how asset accumulation and returns to capital impacts income inequality.

# **IV. Impact of taxes and social spending on poverty and inequality**

## **The impact on inequality**

The combined effect of taxes and social spending help to substantially reduce inequality in Poland. Figure 2A shows the change in the Gini coefficient on account of taxes and social spending following the income concepts defined above for 2014. Prior to any fiscal intervention, market income inequality had a Gini as high as 0.41, if old-age contributory pensions are treated as deferred income and included, but much higher if these pensions are not included. Once direct taxes, social security contributions and noncontributory transfers are included, we end up with a measure of disposable income that has a much lower Gini. Indirect taxes are unequalizing as the Gini increases for consumable income, which includes the impact of VAT and excise taxes. Finally, in-kind transfers in the form of education and health helped to reduce inequality. The overall reduction in inequality was equivalent to 13 Gini points from market income to final income when old-age pensions are considered to be deferred income, but as much as 24 Gini points when pensions are treated as transfers.

The reduction in inequality achieved in Poland is more substantial than what is observed in other new high income countries (such as Chile and Uruguay) countries, even when considering old-age pensions as deferred income, and despite the effects of indirect taxes, largely on account of its spending on education and health (Figure 2B). However, compared to other established high income countries in Europe, the impact of direct taxes and transfers is in line with other EU countries, with most of the reduction in inequality largely being achieved by pensions (Figure 3).

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# Figure 2. Inequality <u>declines after taxes and social spending</u>

A. Poland. Gini Coefficient B. Emerging markets: Gini Coefficient (pensions as deferred income) <!-- Start of picture text --> 0.55 0.60<br>0.53<br>Old-age pensions as<br>Brazil<br>deferred income<br>0.55 Chile (2009)<br>0.50<br>(2009)<br>Old-age pensions as<br>Mexico<br>transfers 0.50 (2010)<br>0.45<br>0.41 Uruguay<br>0.45 (2009)<br>0.40 Georgia<br>(2013)<br>0.35 0.40<br>0.34 Armenia<br>0.35<br>(2011)<br>0.35<br>Russia<br>0.30 0.28 Poland (2010)<br>0.30 (2014)<br>0.25 0.25<br>Market Income Disposable Consumable Final Income Market Disposable Consumable Final Income<br>Income Income Income Income Income<br><!-- End of picture text --> Source: Own estimates using PHBS 2014.

Source: Armenia: Younger et al (2016); Brazil: Higgins & Pereira (2014); Chile: Ruiz-Tagle & Contreras (2010) Georgia: Cancho & Bondarenko (2016); Mexico: Scott (2014); Russia: Lopez-Calvo et al (2016); Uruguay: Bucheli et al (2014); Poland: <u>own estimates using PHBS 2014.</u> <u>Figure 3. Decline in Inequality from Market to Disposable Income</u> <!-- Start of picture text --> 0.00<br>-0.05<br>-0.10<br>-0.15<br>-0.20<br>-0.25<br>-0.30<br>Pensions as deferred income Pensions as transfers<br>Belgium (2014)* Germany (2014)* Hungary (2014)* Austria (2014)* Czech Republic (2014)* Croatia (2014)* Romania (2014)* Poland (2014) Estonia (2014)* Bulgaria (2014)* Russia (2010) Armenia (2011) Uruguay (2009) Brazil (2009) Chile (2009) Mexico (2010)<br><!-- End of picture text --> Source: Armenia: Younger et al (2016); Brazil: Higgins & Pereira (2014); Chile: Ruiz-Tagle & Contreras (2010) Georgia: Cancho & Bondarenko (2016); Mexico: Scott (2014); Russia: LopezCalvo et al (2016); Uruguay: Bucheli et al (2014); EU countries (*): Euromod (2014); Poland: own <u>estimates using PHBS 2014.</u> 16
# **The impact on poverty**

The combination of taxes and social spending also led to an important decline in poverty in 2014. The overall decline amounts to 16 percentage points from market to consumable income for the legal poverty line and 18 percentage points for the extreme poverty line.<sup>11</sup> Most of this decline is on account of contributory pensions, which could be thought of as deferred incomes. Starting from market income, the extreme poverty headcount rate measured using the National extreme poverty line<sup>12</sup> declined from 27.2 to 6 percent mostly on account of contributory old-age pensions (Table 4). Similarly, the legal poverty rate declined from 29.2 to 7.5 percent.

Table 4. Main Scenario: Changes in Poverty on account of taxes and transfers

|Market<br>Income<br>|Market income<br>+ contributory<br>pensions|<br>Disposable<br>Income|Consumable<br>Income|
|---|---|---|---|
|(1)|(2) = (1) +<br>contributory<br>pensions|(3) = (2) - direct<br>taxes -<br>contributions +<br>direct transfers|<br>(4) = (3) -<br>indirect<br>taxes|
|**Poverty headcount**||||
|National legal<br>29.2%|7.5%|8.6%|12.9%|
|National extreme<br>27.2%|6.0%|5.5%|8.9%|
|US $5PPP a day<br>27.3%|6.1%|6.0%|9.2%|
|US $2.5PPP a day<br>19.0%|2.6%|1.9%|2.9%|
|**Poverty gap**||||
|National legal<br>20.5%|3.5%|3.0%|4.7%|
|National extreme<br>19.6%|2.9%|2.3%|3.6%|
|US $5PPP a day<br>19.1%|2.9%|2.4%|3.7%|
|US $2.5PPP a day<br>14.3%|1.6%|1.3%|1.9%|
|**Poverty severity**||||
|National legal<br>17.1%|2.3%|1.9%|2.9%|
|National extreme<br>16.5%|2.0%|1.6%|2.4%|
|US $5PPP a day<br>16.0%|2.0%|1.7%|2.5%|
|US $2.5PPP a day<br>12.4%|1.3%|1.2%|1.7%|
|Source: Own estimates based on HBS 2014.||||

11 The extreme poverty rate reported by GUS in 2014 was 7.4 percent, while the legal poverty rate was 12.2 percent. The discrepancy is largely on account of the fact that these are measured using expenditures instead of income (see GUS: <u>http://swaid.stat.gov.pl/en/WarunkiZyciaLudnosci_dashboards/Raporty_predefiniowane/RAP_DBD_WZL_11.aspx)</u> However disposable income is typically very close to consumption for the population at the bottom of the distribution who typically would not be able to save.

12 We use the definitions used by the Polish Central Statistics Office (GUS) to define the national extreme and legal poverty lines. The starting point adopted for constituting the extreme poverty threshold is subsistence minimum of PLN 544.09 in 2014 estimated by the Institute of Labor and Social Studies for a 1-person household. This value is multiplied by the number of persons in the household according to the original OECD equivalence scale.

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Once direct taxes and all social contributions are subtracted and direct transfers are added, the extreme poverty headcount for disposable income declined further, to 5.5 percent. However the legal poverty headcount increases somewhat to 8.6 percent, on account of the relatively large burden of direct taxes and social contributions for all but those under the extreme poverty line.<sup>13</sup> Once indirect taxes are incorporated into the analysis, all of the improvement in poverty that takes place through direct transfers is canceled out. In fact, indirect taxes result in a 3.5 percentage point increase in extreme poverty when compared to disposable income and a 2.9 percentage point increase when compared to market income plus pensions. Similarly, both the poverty gap and the severity of poverty decline with pensions and social transfers, but increase once indirect taxes are taken into account. Similar results hold when the international US$5-a-day (2005 PPP) and the US$2.5-a-day (2005 PPP) poverty lines are used.

How does this look for different types of households? As shown in Table 5, there is quite a bit of heterogeneity in terms of the impact of taxes and transfers on poverty across different types of households. Although poverty increases with indirect taxes for all types of households, households with children are especially hard hit, with extreme poverty being higher for consumable income than for market income for households with more than one child and the at-risk-of poverty rate being higher for single parents and for couples with children.

Table 5. Main Scenario: Changes in Poverty on account of taxes and transfers by household type

||Market<br>Income|Disposable<br>Income|Consumable<br>Income|Total impact on<br>extreme<br>poverty|
|---|---|---|---|---|
||(1)|(2) =<br>(1) + pensions +<br>direct transfers -|<br>(3) =<br>(2) - indirect<br>taxes|<br>(4) = (3) - (1)|
|||direct taxes -<br>contributions<br>Extrem<br>|ePoverty<br>||
|Overall|27.2%|5.5%|8.9%|-18.3%|
|Single adult|24.4%|6.0%|9.4%|-15.1%|
|Single parent|22.6%|7.0%|10.6%|-12.0%|
|Couple without children|27.4%|3.9%|6.3%|-21.1%|
|Couple with 1 child|6.6%|4.1%|6.1%|-0.5%|
|Couple with 2 children|6.1%|4.7%|8.0%|1.9%|
|Couple with 3+ children|15.9%|9.9%|17.1%|1.3%|
|Single retiree|91.4%|0.5%|1.3%|-90.1%|
|Couple of retirees|93.6%|0.4%|0.8%|-92.8%|
|Mixed|24.0%|6.8%|11.2%|-12.9%|

> 13 Results for the alternative scenario where old age pensions are considered as deferred savings are presented in Appendix 2.

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||At-risk-ofpov|ertyrate (60% of|mediandisposabl|eincome)|
|---|---|---|---|---|
|Overall|34.2%|17.1%|25.1%|-9.2%|
|Single adult|25.8%|9.4%|14.1%|-11.7%|
|Single parent|33.6%|25.1%|35.7%|2.1%|
|Couple without children|30.5%|11.9%|18.1%|-12.5%|
|Couple with 1 child|10.0%|10.6%|16.1%|6.1%|
|Couple with 2 children|10.8%|14.7%|22.6%|11.8%|
|Couple with 3+ children|26.6%|28.0%|41.0%|14.3%|
|Single retiree|96.3%|11.1%|20.0%|-76.3%|
|Couple of retirees|95.5%|2.5%|5.9%|-89.5%|
|Mixed|33.6%|20.8%|29.5%|-4.0%|

<mark>Source: Own estimates based on HBS 2014.</mark>

# **V. Progressivity, Marginal Contributions, and Pro-poorness of Taxes and Transfers**

How did each of the fiscal interventions contribute to the observed changes in poverty and inequality? Figure 4 presents the distributional impact of different components of the tax and benefit system as a share of market income (including pensions). Most components of the system are progressive, with the bottom 50 percent of the distribution being net receivers of social benefits. However in cash terms, households beginning in the second decile were net payers to the treasury in 2014, as the share of taxes paid exceeded the cash benefits received for all but the poorest 10 percent of the population. This coincides with the results presented above, particularly once indirect taxes are included.

Since the influence of specific interventions may be different from that of the overall system, a fundamental question in the policy discussion is whether a particular fiscal instrument (or a particular combination of them) is equalizing. If there were a single fiscal intervention, using the typical indicators such as the Kakwani index<sup>14</sup> to determine whether a particular intervention is progressive or regressive would be sufficient to unambiguously determine whether that intervention was equalizing. Given there is more than one fiscal intervention, this one-to-one relationship between the progressivity of a particular intervention and its effect on inequality breaks down. As Lambert (2001) demonstrates, depending on certain characteristics of the fiscal system, a regressive tax—for example—can exert an equalizing force over and above that which would prevail in the absence of that regressive tax. This is because each fiscal intervention interacts with all the others. For instance, the proceeds of a regressive indirect tax could be used very

> 14 The Kakwani index for taxes is defined as the difference between the concentration coefficient of the tax and the Gini for market income. For transfers, it is defined as the difference between the Gini for market income and the concentration coefficient of the transfer. See, for example, Kakwani (1977).

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effectively in a pro-poor transfer, leading to a situation where post-fisc incomes are more equal than in the absence of that regressive tax.

Figure 4. Poland. Distributional Impact <u>of the Tax and Benefit System in 2014</u> <!-- Start of picture text --> 200%<br>150%<br>100%<br>50%<br>0%<br>-50%<br>Poorest 2 3 4 5 6 7 8 9 Richest<br>Market income deciles<br>Direct taxes Direct transfers VAT (per capita) Excise (per capita)<br>Education Health Net cash position Total<br>Source: Own estimates based on the 2014 HBS.<br>Share of disposable income<br><!-- End of picture text --> One way to calculate the effect of a particular fiscal instrument on inequality is to calculate its marginal contribution. The marginal contribution of a tax (or transfer) is calculated by taking the difference between the inequality indicator _with_ and _without_ the tax (or transfer). Table 6 shows both the Kakwani progressivity index for each tax and transfer along with its marginal contribution to reducing inequality and poverty for each tax and transfer intervention in 2014 under the main scenario. Results for the alternative scenario where old age pensions are considered as deferred savings are presented in Appendix 2. We describe each of these in turn.

# **Taxes**

Direct taxes and social contributions are only slightly progressive overall, and while they are redistributive, they place an important burden on the poor. This can be seen by the fact that the Kakwani coefficient is positive, indicating that taken together direct taxes and contributions are progressive, and by positive marginal contributions, indicating that they are redistributive (Table 6). However, direct taxes and contributions are also poverty increasing, as shown by a negative 20
# **Table** **<u>6. Main Scenario: Marginal Contributions to Reducing Inequality in 2014</u>**

|||||**Mar**|**ginal Contri**|**butions**|
|---|---|---|---|---|---|---|
||**Size**|**Concentration**<br>**Coefficient**|<br>**Kakwani**<br>**Coefficient**|Redistributive<br>effect|Poverty<br>reduction<br>effect US$5|Poverty reduction<br>effect National<br>Extreme|
|**Total from Market to Consumable Income**|||||||
|Direct transfers(excludingcontributory pensions)|1.9%|-0.6066|0.9825|0.0257|0.0480|0.0466|
|Housingbenefits|0.1%|-0.5890|0.9649|0.0016|0.0031|0.0029|
|NursingBenefit(zasiłek)|0.1%|-0.4608|0.8367|0.0013|0.0023|0.0022|
|NursingAllowance(świadczenie)|0.2%|-0.5678|0.9437|0.0026|0.0049|0.0047|
|Social assistance|0.3%|-0.7461|1.1220|0.0049|0.0085|0.0080|
|Familybenefits|0.4%|-0.6561|1.0320|0.0064|0.0171|0.0147|
|Socialpension|0.6%|-0.5532|0.9291|0.0076|0.0128|0.0124|
|Contributory pensions|23.3%|0.1709|0.2050|0.3165|0.2956|0.2949|
|Old-agepension|17.5%|0.2159|0.1600|0.2191|0.2107|0.2114|
|Other contributorybenefits|0.1%|0.2509|0.1251|0.0004|0.0006|0.0007|
|Pre-retirementpension|0.3%|-0.1488|0.5247|0.0030|0.0044|0.0040|
|Family pension|2.0%|0.1548|0.2211|0.0230|0.0257|0.0259|
|Disability pension|1.9%|-0.1269|0.5028|0.0216|0.0292|0.0302|
|Maternitybenefit|0.8%|0.2735|0.1025|0.0077|0.0113|0.0107|
|Unemployment benefit|0.4%|-0.1872|0.5631|0.0060|0.0087|0.0091|
|Structural farmerpension|0.2%|-0.0970|0.4730|0.0018|0.0023|0.0023|
|Direct taxes and contributions|30.0%|0.4205|0.0446|0.0137|-0.0424|-0.0413|
|Health insurance contributions|6.4%|0.3841|0.0082|0.0017|-0.0135|-0.0138|
|Capital taxes|0.0%|0.5675|0.1915|0.0000|0.0000|0.0000|
|Farm taxes|0.3%|-0.0587|-0.4347|-0.0019|-0.0025|-0.0023|
|Personal income tax|4.9%|0.5631|0.1872|0.0150|0.0016|-0.0003|
|Old-agepension contributions|10.4%|0.4080|0.0321|0.0001|-0.0230|-0.0213|
|Disability pension contributions|4.3%|0.4080|0.0321|-0.0012|-0.0124|-0.0113|
|Accident insurance contributions|1.0%|0.4269|0.0510|-0.0002|-0.0034|-0.0034|
|Sickness insurance contributions|1.2%|0.4402|0.0643|0.0000|-0.0034|-0.0037|
|Labor Fund|1.3%|0.4269|0.0510|-0.0002|-0.0043|-0.0041|
|Fund of Employee Benefits|0.0%|0.4402|0.0643|0.0000|0.0000|-0.0006|
|Pension contributions - farmers|0.2%|-0.2491|-0.6251|-0.0016|-0.0019|-0.0018|
|Other contrib - farmers|0.1%|-0.2800|-0.6559|-0.0008|-0.0011|-0.0009|
|Indirect taxes|8.9%|0.2602|-0.1157|-0.0140|-0.0331|-0.0355|
|Value-added tax|6.6%|0.2676|-0.1083|-0.0103|-0.0252|-0.0257|
|Excise taxes|2.3%|0.2383|-0.1376|-0.0054|-0.0108|-0.0112|
|**Total from Market to Final Income**|||||||
|Direct taxes and contributions|30.0%|0.4205|0.0446|0.0261|-0.0079|-0.0091|
|Direct transfers(excludingcontributory pensions)|1.9%|-0.6066|0.9825|0.0156|0.0163|0.0168|
|Indirect taxes|8.9%|0.2602|-0.1157|-0.0066|-0.0084|-0.0096|
|In-kind transfers|19.2%|-0.0858|0.4617|0.0746|||
|Education|11.6%|-0.1382|0.5142|0.0356|||
|Kindergarten benefits|0.8%|0.0890|0.2869|0.0016|||
|Primaryschool benefits|4.0%|-0.1891|0.5650|0.0168|||
|Gymnasium benefits|2.0%|-0.2429|0.6189|0.0088|||
|High school benefits|0.6%|-0.0854|0.4613|0.0016|||
|Vocational school benefits|0.9%|-0.3245|0.7005|0.0048|||
|Tertiaryschool benefits|2.3%|0.1564|0.2195|-0.0003|||
|Health<br>Source: own estimates based on 2014 HBS.|7.6%|-0.0056|0.3816|0.0294|||

1. Size equals the ratio of the amount collected or spent divided by total market income.

2. Redistributive effect equals the difference in the Gini before and after the intervention.

3. By definition, the sum of the marginal contributions does not fulfill the adding-up principle so it will not be equal to the redistributive/overall poverty effect unless by coincidence.

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marginal contribution to poverty reduction when measured by the extreme and the US$5-a-day poverty line.<sup>15</sup> Moreover, there is substantial heterogeneity across categories of taxes and contributions. For instance, while personal income taxes are progressive and redistributive, many of the social contributions are not progressive and pose a burden on the extreme poor. This is because in general there is no minimum threshold for social contributions. Under the scenario that contributory oldage pensions are a deferred income, we find that even health insurance contributions are regressive and place a burden on the poor (see Appendix 2). Worse yet, agricultural taxes and farmer pension contributions are regressive in all scenarios, and contribute not only to increased poverty, but also to higher inequality. This is partly due to the fact that agricultural taxes and contributions are based on land size rather than on income, such that they can make up a larger share of market incomes of poor households. Together, direct taxes and contributions were only slightly progressive in 2014, but much less so than in other countries (Figure 5A), and while they were redistributive, they also posed an important burden on the poor.

Indirect taxes are regressive and contributed to increasing poverty and inequality as discussed in the previous section. While it is true that regressive taxes can be equalizing, this was not the case in Poland in 2014. In particular, VAT placed a large burden on low-income households, which was not compensated for by pro-poor spending, leading to an overall increase in poverty and inequality. Excise taxes were even more regressive, but since they are not as large as VAT, their impact on poverty and inequality was not as severe (Table 6). When taken together, the regressive and unequalizing nature of indirect taxes in Poland is higher than what is observed in many Latin American and other developing countries (Figure 5B). These results point to potential improvements that could be achieved to reduce the burden on the poor.

# **Social Spending**

Contributory pensions and direct transfers are all progressive, reducing both poverty and inequality (Table 6). Contributory old-age pensions are particularly large, and while not as progressive as other pensions, have an important poverty-reducing and redistributive effect (Table 6). Moreover, contributory benefit programs are progressive only in relative terms – that is, they represent a larger share of the budgets of the poor, but they are not pro-poor, as most of the benefits are concentrated at the top 40 percent of the distribution. Although disability and unemployment benefits are more concentrated at the bottom of the distribution, maternity, family and old-age pensions are relatively more concentrated at the top (Figure 6).

> 15 We find similar results using higher poverty lines, such as the legal poverty line.

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<!-- Start of picture text --> Figure 5. Progressivity and Redistributive Effect of Taxes<br>Figure A. Direct Taxes<br>0.70 0.035<br>0.60 0.030<br>0.50 0.025<br>0.40 0.020<br>0.30 0.015<br>0.20 0.010<br>0.10 0.005<br>0.00 0.000<br>Kakwani Marginal contribution<br>Figure B. Indirect Taxes<br>0.10 0.010<br>0.05<br>0.005<br>0.00<br>0.000<br>-0.05<br>-0.005<br>-0.10<br>-0.010<br>-0.15<br>-0.015<br>-0.20<br>-0.25 -0.020<br>Kakwani Marginal contribution<br>Kakwani Index<br>(change in Gini points)<br>Marginal contribution to equity<br>Regressive <------------------> Progressive<br>(change in Gini points)<br>Kakwani Index Marginal contribution to equity<br>Regressive <------------------> Progressive<br><!-- End of picture text --> Source: Source: Armenia: Younger et al (2016); Bolivia: Paz Arauco et al (2014); Brazil: Higgins & Pereira (2014); Chile: Ruiz-Tagle & Contreras (2014); Colombia: Melendez (2014); El Salvador: Beneke et al., (2014); Georgia: Cancho & Bondarenko (2016); Mexico: Scott (2014); Peru: Jaramillo (2013); Russia: Lopez-Calvo et al (2016); Sri Lanka: Arunatilake et al (2016); South Africa: Inchauste et al (2016); Uruguay: Bucheli et al (2014); Poland: own estimates based on the 2014 HBS.

Note: Old-age pensions are treated as deferred income for all countries shown. Marginal contributions are the <u>difference between the consumable income Gini coefficient with and without indirect taxes.</u> 23
Among non-contributory transfers, family benefits and social assistance programs are the most progressive, but social assistance has a relatively small redistributive effect given its small size (Table 6). Social pensions have the largest redistributive effect, and together with family benefits have the largest impact on extreme poverty. With the exception of the child birth grant, all of the noncontributory programs are targeted to the bottom 20 percent of the distribution (Figure 6).

In assessing how education and health spending benefit the poor, we have to caution that our analysis does not address the quality of such spending. We use government expenditure data on the various forms of education and health services to estimate unit costs of these programs. The analysis thus assumes that the actual benefit received by individuals is equal to the amount spent per capita. As the quality of school infrastructure, teachers, and health clinics and hospitals vary across the country then this is a clear limitation of the analysis.

The results show that both education and health are progressive and equalizing.<sup>16</sup> For education, 29 percent of total education spending goes to the bottom 20 percent of the distribution, while only 15 percent was concentrated at the top 20 percent. This is mostly on account of primary school spending which has the largest redistributive effect (Table 6). Indeed, primary, gymnasium and vocational school spending benefit families at the bottom of the distribution slightly more than those at the top, in part because lower income households tend to have more children (Figure 7). Interestingly, tertiary education spending is much less concentrated at the top of the distribution than what is typically observed in middle-income countries. It is also interesting to note that 26 percent of spending on kindergarten is benefiting the top 20 percent of the distribution, mostly on account of greater access to these services in urban areas. However, this could also reflect the fact that the subsidy for private kindergarten is as much as 75 percent of the standard subsidy for public services.

Health spending is equally distributed across the population, with slightly more (20.3 percent) spending concentrated at the bottom 20 percent of the distribution given that some wealthier households opt-out of public care (so that 19.7 percent of health spending is concentrated at the top 20 percent). Note that in relative terms, health spending is strongly progressive, as it makes up a larger share of the incomes of the bottom of the distribution.

> 16 Following CEQ conventions, we do not assess the poverty reducing impact of health and education spending, since households do not necessarily feel wealthier on account of this spending. Moreover, since these are investments in human capital, the full benefit of this spending will not be clear in a static setting such as this one.

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<!-- Start of picture text --> Figure 6. Concentration of Social Protection Programs by market income quintiles<br><!-- End of picture text --> <!-- Start of picture text --> 100%<br>90%<br>80%<br>70%<br>60%<br>50%<br>40%<br>30%<br>20%<br>10%<br>0%<br>Contributory pensions Non-contributory benefits<br>Poorest 2 3 4 Richest<br>Old-age pension Other pensions Pre-retirement pension Family pension Disability pension Maternity benefit Unemployment benefit Structural (farmer) pension Housing benefits Child birth grant Nursing Benefit (zasiłek) Nursing Allowance Social assistance Family beneifts Social pension<br><!-- End of picture text --> <u>Source: World Bank estimates based on HBS 2014.</u> Figure <u>7. Concentration of Education and Health by market income quintiles</u> <!-- Start of picture text --> 100%<br>90%<br>80%<br>70%<br>60%<br>50%<br>40%<br>30%<br>20%<br>10%<br>0%<br>Poorest 2 3 4 Richest<br><!-- End of picture text --> <u>Source: World Bank estimates based on HBS 2014.</u> 25
# **VI. What is the impact of recent changes in taxes and benefits?**

Since 2014, the government has implemented changes to the tax and transfer system, with the recent introduction of the Family 500+ program being the most important. Going forward, proposals to reform the tax system are being considered, aiming to make it more progressive. This section presents simulations for these changes, with a focus on the overall impact on poverty and inequality. Although we present initial estimates of the fiscal cost of each of these measures, it is important to note that the sustainability and labor incentive effects are not considered in this paper, although they could be substantial, and should be carefully considered in conjunction with the results presented below.

## **Family 500+ Program**

Facing one of the lowest fertility rates in the EU, the Government of Poland has recently introduced a new Family benefit program with two formal objectives: (i) to encourage fertility, and (ii) to reduce child poverty. The Family 500+ program was rolled out in April 2016 and consists of a monthly payment of PLN 500 (€115) for every second and subsequent child until the age of 18. The benefit is also extended to the first child in families with income per capita below PLN 800, or below PLN 1,200 (€274) if there is a disabled child in the family. The program does not include an income threshold for high income earners, and payments are to be administered by municipal social assistance units based on the funding from the State Budget.

Since this benefit was extended to all children, not just those born after the program began, this represents a relatively large increase in transfers to households in Poland. Importantly, the Family 500+ benefit is designed to be on top of any other existing social assistance benefit received by the household (such as family benefits, housing allowance, other social assistance, or payments from the alimony fund) and will not influence the eligibility to these aforementioned programs. Eligibility into the program for farming households, will depend on the amount of land owned by the family and the standardized income per hectare announced by the Polish Central Statistical Office.

In order to simulate the distributional impacts of the Family 500+ program, we classify household members into families using the program eligibility rules.<sup>17</sup> As described earlier for the analysis presented above, sampling weights from the HBS were calibrated as in Myck & Najsztub (2015) in order to account for differences on the number of children between the HBS and the census. Moreover, since the survey reports income at the household level, in order to obtain family per

> 17 A family includes the parents of the children, the spouse of the parent, caregiver of the child, and children up to 25 who reside with the parents and who are economically dependent on the parents. A family may also include children older than 25 provided that these are disabled and due to their disability are eligible for caregiver allowance. Children will not be considered as a part of the family if the child is married, or if the child is older than 18 and already has a child of his/her own.

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capita income we first determine individual incomes, allocating general household income evenly among all household members. Additionally, for farming households, their reported income is ignored in order to determine eligibility to receive the allowance for the first child and the predicted income is based on the amount of land belonging to the household is evenly distributed among all family members.<sup>18</sup> We therefore construct an income per capita measure in line with the eligibility criteria that will be used in order to qualify for the benefit for the first child, including income from wages, income from capital, income from pensions, and income from transfers categorized as alimony. This measure of income is then used to estimate monthly payments to be delivered across the distribution as part of the Family 500+. Finally, since households are expected to increase their spending, we also compute the likely increase in VAT and excise spending due to the Family 500+ program.

Since Family 500+ is not targeted to low-income households for families with 2 or more children, 13 percent of benefits are expected to benefit the top 40 percent of the distribution, pointing to potential efficiency gains if it were to be better targeted. However, since low-income households have more children, 44.5 percent of benefits will go to the bottom 20 percent of the distribution. Although the Family 500+ program is less progressive than the social assistance and family benefit program, it is more redistributive and has a greater impact on extreme poverty than either of those programs given its relative size (Figure 8).

Poverty and inequality are therefore expected to fall after the introduction of the Family 500+ program. Indirect taxes are also expected to increase, but assuming households spend on similar goods, the net effect on consumable income is still estimated to be positive, with extreme poverty declining from 8.9 to 5.9 percent relative to the situation in 2014 (Table 7).

<!-- Start of picture text --> Figure 8. Progressivity and Marginal Contribution – Family 500+<br>1.20 0.045<br>0.040<br>1.00<br>0.035<br>0.80 0.030<br>0.025<br>0.60<br>0.020<br>0.40 0.015<br>0.010<br>0.20<br>0.005<br>0.00 0.000<br>Kakwani Coefficient<br>Redistributive effect (Gini points, right)<br>Reduction of extreme poverty (percentage points, right)<br>Source: World Bank estimates based on HBS 2014.<br>Kakwani Index<br>--------------> Progressive Marginal contribution<br><!-- End of picture text --> The cost of the program is expected to amount to PLN 25.7 million per year (1.5 percent of GDP). However, when we take into account the likely increase in VAT and excise tax collections (assuming that households will consume a similar basket of goods after the program is put in

> 18 It is ignored only for the eligibility for all income concepts presented later the reported income is utilized. The value per hectare considered is PLN 2,506 per annum.

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place), the net cost of the program is expected to amount to PLN 22.2 million per year (1.3 percent of GDP).

To compare the <u>Figure 9. Spending Efficiency</u> efficiency of the new 0.020 Redistributive efficiency 0.025 program relative to 0.018 Poverty-reducing efficiency 0.016 0.020 other existing 0.014 programs, we 0.012 0.015 calculate the change 0.010 in poverty and 0.008 0.010 0.006 extreme poverty per 0.004 0.005 zloty spent for each 0.002 program. We find that 0.000 0.000 the change in poverty and inequality per zloty spent is lower for the Family 500+ program compared to <u>Source: World Bank estimates based on HBS 2014.</u> social assistance, family benefits, social pension and housing benefits, as these are more targeted, but it is more cost efficient than nursing allowance and nursing benefit (Figure 9). However, it must be kept in mind that last two benefits are not means-tested or targeted to the poor as their aim is to support persons suffering from disability.

# **Increasing the tax-free allowance for Personal Income Taxes**

In addition to the Family 500+, the new government campaigned on a promise to increase the taxfree allowance for PIT from PLN 3,000 to PLN 8,000. However, the plans have not yet been detailed, and the size of the increase might end up being lower, potentially to be implemented in several steps. The simulations below present two scenarios, one in which the tax-free allowance increases to PLN 5,000, and the other where it increases to PLN 8,000. We present the impact on poverty and inequality, along with the estimated fiscal cost of these measures. Given the introduction of the Family 500+, we also show the impacts of these alternative reforms in combination with the Family 500+ program.

Increasing the value of the tax-free allowance leads to more progressive personal income tax and health insurance contributions (since health contributions partly depend on the amount paid in PIT), resulting in an overall more progressive and redistributive direct tax system (Figure 10). The increase in disposable income as a result of the tax-free allowance is assumed to slightly increase the burden of indirect taxes. However, the net effect is a net gain for all households.

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Combining the effect of the Family 500+ and the increase in the change in the tax-free allowance leads to a further reduction in poverty and inequality. Most of the change results from the introduction of the Family 500+ program, as shown in Table 7, with inequality declining by an additional 0.2 to 0.5 Gini points and extreme poverty by 0.3 to 0.6 percentage points, depending on the size of the allowance. The Figure 10. Progressivity and impact of direct taxes and <u>contributions under alternative reforms</u>

|0000<br>0.010<br>0.020<br>0.030<br>0.040<br>0.050<br>0.060<br>0.070<br>0.080<br>Kakwani Index<br>gressive <----------------><br>Progressive|||0000<br>0.005<br>0.010<br>0.015<br>0.020<br>0.025<br>0.030<br>0.035<br>Marginal contribution|
|---|---|---|---|
|.<br>2014<br>Baseline<br>Re|Includes<br>Family<br>Family<br>500+ and|Family<br>500+ and|.|
||500+<br>Tax-free|Tax-free||
||amount|amount||
||PLN 5000|PLN 8000||
|Kakwani|Redistributive effect (G|ini points)||
|Source: WorldBankestimate|s based on HBS2014.|||

cost of these programs ranges from an additional PLN 7.5 (0.4 percent of GDP) to PLN 19 million (1.1 percent of GDP) relative to the cost of Family 500+ program alone. This estimate takes into account an expected increase in consumption and therefore in indirect taxes (under the assumption that households consume a similar basket of goods).

Table 7. Impact of Family 500+ and Alternative Tax Allowance Reforms

||Market<br>Income|Market income<br>+ contributory<br>pensions|Disposable<br>Income|Consumabl<br>e Income|Final<br>Income|Estimated Fisc|al Cost|
|---|---|---|---|---|---|---|---|
||(1)|(2) = (1) +<br>contributory<br>pensions|(3) = (2) -<br>direct taxes -<br>contributions<br>+ direct<br>transfers|(4) = (3) -<br>indirect<br>taxes|(5) = (4)<br>+ inkind<br>transfers|(million PLN per<br>year)|(percent<br>of GDP)|
|**Gini**||||||||
|202014 Baseline|||0.3428|0.3547|0.2821|||
|1) Family 500+|||0.3133|0.3270|0.2704|22,181|1.3%|
|2) PIT allowance at PLN 5000|05265|03759|0.3397|0.3517|0.2799|8,873|0.5%|
|3) PIT allowance at PLN 8000<br>Sim|.|.|0.3356|0.3477|0.2768|22,582|1.3%|
|4) Family 500+ & PIT allowance at PLN 5000|||0.3107|0.3245|0.2682|29,702|1.7%|
|5) Family 500+ & PIT allowance at PLN 8000|||0.3076|0.3214|0.2652|41,172|2.4%|
|**Extreme Poverty**(percent of population)||||||||
|202014 Baseline|||5.5%|8.9%||||
|1) Family 500+|||3.4%|5.9%||||
|2) PIT allowance at PLN 5000|272%|60%|5.1%|8.5%||||
|3) PIT allowance at PLN 8000<br>Sim|.|.|4.8%|7.9%||||
|4) Family 500+ & PIT allowance at PLN 5000|||3.2%|5.6%||||
|5) Family 500+ & PIT allowance at PLN 8000<br>Source: Own estimates based on HBS 2014.|||3.1%|5.3%||||

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Since the proposed taxfree amounts will apply to all taxable incomes, a larger share of the benefits are expected to benefit households at the top of the distribution, pointing to efficiency gains that could be possible if the proposed tax break were better targeted. As shown in Figure 11, the poverty and inequality reducing impact per zloty spent is

|Figure 11. Inequality and Poverty-reducing efficiency Family<br>andTax-free allowance|500+|
|---|---|
|Family 500+ & PIT<br>allowance at PLN<br>Family 500+ & PIT<br>allowance at PLN||
|Family 500+<br>5000<br>8000||
|PLN 22.2<br>1.2<br>0.14<br>ine||
|PLN 29.7<br>PLN 41.2<br>0.0<br>0.2<br>0.4<br>0.6<br>0.8<br>1.0<br>0.00<br>0.02<br>0.04<br>0.06<br>0.08<br>0.10<br>0.12<br>Change in Gini relative to Basel<br>(per PLN spent)|Change in extreme poverty<br>(per PLN spent)|
|Redistributive efficiency<br>Poverty-reducing efficiency||
|Source: WorldBankestimates based on HBS2014.||

lower for scenarios that include the tax-free allowance compared to the Family 500+ program alone. About 48 percent of the foregone revenue will benefit households in the top 40 percent of the distribution, while only 30 percent will benefit the bottom 40 percent. In relative terms, the tax break represents 4 to 7 percent of disposable income for the poorest 40 percent, but only 2 to 4 percent for the top of the distribution. These results point to potential efficiency gains by restricting the program to households at the bottom of the distribution.

How do the changes above affect the net cash position of households before and after the reforms? Households in the second decile will now receive more in transfers than they pay into the system through direct and indirect taxes and contributions largely due to the Family 500+ program, although all households will have a net gain (Figure 12). Going forward, it will be important to consider how these initiatives will be financed, and the potential distributional impact of measures needed to ensure that the government is able to keep to its deficit rule.

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<!-- Start of picture text --> Figure 12. Net cash position of households under alternative reforms<br>100%<br>2014 Baseline<br>80%<br>Includes Family 500+<br>60%<br>Family 500+ and Tax-free<br>amount PLN 5000<br>40%<br>Family 500+ and Tax-free<br>amount PLN 8000<br>20%<br>0%<br>-20%<br>-40%<br>Poorest 2 3 4 5 6 7 8 9 Richest<br>Market income deciles<br>Source: World Bank estimates based on HBS 2014.<br>Percent of original market income<br><!-- End of picture text -->

# **VII. Conclusions**

The analysis presented in this paper is complementary to existing work analyzing the distributional impact of taxes and benefits. As previous work has shown (Paulus, 2015; Myck and Najsztub, forthcoming), the combined effect of taxes and social spending helps to substantially reduce inequality in Poland, in line with other EU countries, with most of the reduction in inequality largely being achieved by pensions. This paper also shows the important role of in-kind transfers in the form of education and health. Moreover, we find that the combination of taxes and social spending also leads to an important decline in extreme poverty. However, in cash terms, households beginning in the second decile were net payers to the treasury in 2014, as the share of taxes paid exceeded the cash benefits received for all but the poorest 10 percent of the population.

In terms of the specific fiscal interventions, we find that most direct taxes are progressive and equalizing with the exception of agricultural taxes and farmer contributions, which depend on land size rather than on the income generation capacity of households. In addition, although direct taxes and contributions are progressive, they are also poverty increasing as they pose a significant burden on the bottom of the distribution given that contributions do not have a minimum threshold. Even when old-age pensions are assumed to be deferred income, we find that the personal income taxes and health insurance contributions are poverty increasing. Moreover, indirect taxes are found to be regressive in line with previous work (Myck, 2015b). However, the paper notes that the burden of indirect taxes contributes to poverty and inequality increases, more so than what is observed in many developing countries. Both the results on direct and indirect taxes point as of 2014 to potential areas where Poland could improve, even if it were only to minimize the impact on 31
extreme poverty, particularly for households with children. On the spending side, the paper shows that direct transfers are progressive and equalizing, particularly the family benefit and social assistance programs, which are pro-poor. In line with existing research, we find that contributory benefit programs made up a large share of the incomes of the poor, and had strong poverty reducing and equalizing effects, although they were not pro-poor. Finally, spending on health and education is progressive and equalizing.

Overall, the Polish fiscal system in 2014 had the capacity to redistribute, but a relatively weak capacity to reduce poverty given the resources at its disposal, particularly for families with children. Simulations show that the recent introduction of the Family 500+ program has already made an important change in this respect, strongly reducing the impact of taxes and transfers on extreme poverty and improving the redistributive impact of the system as a whole. The new program is redistributive even if not very well targeted, pointing to potential efficiency gains by restricting the program to households at the bottom of the distribution. Similarly, proposals to extend the tax-free amount in personal income tax legislation are expected to further improve the redistributive impact of fiscal policy. However, a larger share of foregone revenue would benefit the top of the distribution, pointing to potential efficiency gains by restricting the program to households at the bottom of the distribution.

More generally, going forward it will be important to consider how these initiatives will be financed, and the potential distributional impact of measures needed to ensure that the government is able to keep to its deficit rule. Having a comprehensive framework to further analyze alternative reforms is expected to be useful going forward.

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