Functional income distribution, inequality and the effectiveness of fiscal redistribution: evidence from OECD countries

Using panel data on 34 OECD countries followed from 2000 to 2015, we analyse the extent to which the labour share plays a role in mitigating the link between market and disposable income inequality in the non-comprehensive personal income tax hypothesis (i.e. when some or all capital income items are excluded from the personal income tax base). We find that one standard deviation increase of labour share is significantly related to a 9-percentage points reduction in the elasticity of disposable income inequality with respect to market income inequality. This important result obtained after controlling for country and year fixed effects, country-specific linear trends and several variables capturing the characteristics of the taxbenefit system in terms of overall progressivity, suggests that labour share could be considered as an “automatic stabilizer†of income inequality. Relevant implications for tax policy concern the role of the tax base of the personal income tax for the overall redistributive effect of the public budget.