A Fresh Look at an Old Question: Is Pro-Poor Targeting of Cash Transfers More or Less Effective in Terms of Reducing the Incidence of Income Poverty and Inequality?

Thursday, 2 July 2015: 10:15 AM-11:45 AM
TW2.1.04 (Tower Two)
Abigail McKnight, LSE, London, United Kingdom
In this paper we estimate the changing effectiveness of cash transfers and income taxes on inequality and poverty reduction in four EU countries – the UK, Italy, Sweden and France.

The relationship between the degree of targeting of transfers and its effectiveness in producing a more equitable distribution of income has been the focus of a number of research papers.  Arguably the most influential in this field is the paper by Korpi and Palme (1998) who presented empirical cross-country estimates suggesting that more targeted welfare transfers systems were less effective in terms of reducing inequality than more universal systems.  Recent evidence has challenged this stylized fact (Marx, Salanauskaite and Verbist, 2013; Kenworthy, 2012).  These more recent studies have shown that with a wider selection of countries than that used by Korpi and Palme and more recent observations, the relationship is much less conclusive and in many cases no longer holds, although they continue to highlight the importance of the generosity of the system of cash transfers.

In this paper we focus on four countries with contrasting welfare systems allowing us to provide an in-depth analysis of the evolution of welfare systems in these countries.  We use long time series (up to 40 years) to examine trends within countries over time and between countries at different points in time.

The policy interest in understanding the relationship between concentration of cash transfers (most commonly operationalised through means-testing) and redistributive effectiveness intensifies the need to provide clear answers.  Korpi and Palme acknowledge that their finding might appear to be counterintuitive.  One side of the debate stresses the need to focus limited resources on helping those most in need and this has intuitive appeal.  Others argue that a more inclusive welfare state based around a universal system of entitlements leads to a more sustainable, generous system of cash transfers and lower poverty and inequality despite some ‘inefficiencies’. 

Within each of the four countries the analysis in this paper maps the evolution of poverty, inequality and the concentration of cash transfers.  Separate estimates of trends in the concentration of gross social assistance and universal cash transfers provide an indication of how policy changes have affected the extent to which cash transfers have been targeted at lower income households.  These contribute to the bigger picture on the overall concentration of cash transfers which is affected by generosity, the combination of the two types of transfers and finally the progressivity of the income tax system including tax liabilities on income from cash transfers (for example in Sweden and France).

Micro-data from the Luxembourg Income Study are used to compute estimates of income poverty rates and inequality indicies before and after direct income taxes and cash transfers.  These are compared with estimates of the concentration of cash transfers on lower income households.  Estimates are computed for the all age population and for the working age population separately as transfers to the elderly population (mainly in the form of pensions) and assumptions about the counterfactual pre-transfer distribution can produce very different estimates of redistribution and concentration.  We make use of the full time scale available in the LIS dataset for the four countries included in this study.  This means that for the UK we are able to provide estimates for 11 observations over the period 1969 to 2010; for Sweden 8 observations over the period 1967 to 2005; for Italy 11 observations over the period 1986 to 2010 and France 6 observations over the period 1978 to 2005.  The ability to examine changes in concentration over time within countries and the relationship between these and changes in the effectiveness in terms of poverty reduction and redistribution is critical for understanding this relationship.

The key existing comparative studies rely on estimating a bivariate relationship between the variables of interest across a number of countries at a point in time and compare different points in time. There are of course a number of explanations for why estimated cross country relationships can be spurious. 

This research builds on this earlier experience to provide a detailed study of how the relationship between the concentration of cash transfers, the generosity of these transfers and their redistributive impact (poverty reduction and inequality) evolves both between and within a small selection of countries over time.

The empirical findings show that despite the fact that recent evidence suggests that the country-level bivariate estimates of the relationship between concentration of cash transfers and their redistributive effectiveness has become blurred over time, the estimates within countries over time are much more conclusive.  The results show a negative relationship between the concentration of cash transfers and their effectiveness in terms of reducing poverty and inequality.  The strength of the relationship varies between countries and in some cases between the all age and the working age populations.  The evidence suggests that caution should be applied to relying on bivariate cross-country estimates and the paper concludes that more should be done to establish and verify empirical relationship within countries over time using the rich data sources that are now available to researchers.