THE rising income inequality is a growing concern for policymakers in many countries, according to IMF officials.

The problem has worsened since the Great Recession of 2008-09. Income inequality has been increasing in many advanced and even high growth developing economies including China and India since 1980s.

An IMF staff discussions note on ‘Inequality and fiscal policy’ traces the roots of the problem in developed economies to a range of factors including: a) widening inter-regional inequality within economies (b) downward pressure exerted by globalisation on wages of low-skilled labour (c) technological change favouring high skilled workers and (d) decrease in bargaining power of workers.

While there are economists, quoted by the IMF paper, who deem income inequality necessary to provide incentives for investment and economic growth, some others say that there is also evidence that high inequality may retard growth. They maintain that ‘rising income inequality was an important contributing factor to the recent financial crisis.’

The paper quotes economists Fitoussi and Saraceno (2009) who argue that “rising inequality has depressed aggregate demand, resulting in a monetary policy that has maintained low interest rates, thus fuelling a debt spiral among households. This was exacerbated by investor behaviour which created an asset bubble as investors searched for higher returns.”

Similarly, Kumhof and Ranciere (2010) show that in the United States, the Great Depression starting in 1929 and the Great Recession in 2007 were both ‘preceded by a sharp increase in income and wealth inequality and by a rapid rise in debt-to-income ratios among the lower and middle-income households.’

The report written by IMF officials Francesca Bastagi, David Cody and Sanjeev Gupta notes that although fiscal policy has played a key role in reducing income inequality in advanced economies in the past decades, its redistributive impact has diminished since the mid-1990s.

Since the mid-1990s, disposable-income inequality has increased due to the reduced generosity of redistributive social benefits and the diminished progressivity of income taxes.

Addressing this decline in the redistributive impact of fiscal policy in the context of rising marketinequality will require a combination of tax and expenditure policy measures, with due recognition of potential equitytrade

On the tax side, a key issue will be the potential for increasing the redistributive impact of direct income taxes. Priority should be given to reducing opportunities for tax avoidance and evasion practices that typically disproportionately benefit those at the top end of the income distribution.

In addition, there may be scope for raising average and marginal tax rates in economies with relatively low rates. However, increasing the top marginal income tax rates applied to the richest one per cent of the population may require greater international cooperation to be effective.

On the expenditure side, countries will need to avoid the continued decline in the most redistributive cash and intransfers. While reforms aimed at enhancing the redistributive impact of transfers (e.g., through greater use of meansand inbenefits) can help, the redistributive power of these transfers is limited by the work disincentives they can create.

These measures described will also contribute to reducing income inequality in advanced economies needing to implement fiscal consolidation over the medium-term. Over the short- term, protecting the most redistributive social benefits (including unemployment benefits) until the economy recovers and unemployment starts to decline, can help to cushion aggregate demand and mitigate adverse impacts on income inequality.

In addition, expanding active labour market programmes (such as jobsupport, targeted wage subsidies, and training programmes) can help to accelerate the decrease in unemployment as economic growth resumes and can help avoid persistently high unemployment levels.

Over the medium term, somewhat greater reliance on tax measures, as well as broadening the coverage of expenditure reforms to include such items as military spending and subsidies, would obviate the need for large cuts in redistributive transfers.

Enhancing the capability of fiscal policy to address income inequality in developing economies will require strengthening both their resource mobilisation capacity as well as their capacity to use more progressive tax and spending instruments.

A significant proportion of the higher income inequality in developing economies, as compared to advanced economies, can be explained by the lower levels of taxation and public spending in developing economies, as well as their greater reliance on less progressive tax and spending instruments. Addressing these challenges will require raising tax revenues and spending them more efficiently and equitably.

On the tax side, much can be done to improve the distributional impact of fiscal policy. In the shortresource mobilisation efforts should focus on broadening income and consumption tax bases. Expanding corporate and personal income tax bases by reducing tax exemptions, closing loopholes, and improving tax compliance would raise revenues to finance progressive transfers. Expanding the consumption tax base (e.g., through broader adoption of the valueadded tax) would increase tax revenues, and these consumption taxes can also be designed to mitigate adverse distributional impacts (e.g., through appropriate treatment of small businesses and the application of excises to luxury goods).

On the expenditure side, revenue constraints will require greater reliancetargeted (as opposed to universal) social expenditures aimed at protecting households from poverty and improving education and health outcomes among disadvantaged households.

Eliminating fiscally costly and inefficient universal price subsidies (including tax expenditures) can generate substantial resources in the short- term in many economies.

The recent success of conditional cash transfer programmes in many economies suggests that these programmes should play a greater role in the social protection .strategies in developing economies.

Broadening the coverage of public pension systems would also have an important role in reducing inequality. Where expansion is constrained over the short- term by administrative capacity and fiscal constraints, greater use of targeted social pensions may be warranted.