Democratic Compensation or Winner-Take-All Domination? The Distributional Effects of Tax-and-Transfer Policies in 21st Century Europe

Authors – Mads Andreas Elkjaer, Fabian Mushovel.

Abstract :

Market inequality has surged since the 1980s, with most of the gains of growth going to individuals at the top of the income distribution. An increasingly popular interpretation of this development is that not only has the economy become increasingly winner-take-all, but so has politics. Macro studies on redistribution argue that governments no longer respond to inequality; instead, they implement policies that actually exacerbate it. A related, survey-based literature argues that this outcome is a consequence of affluent groups exerting an outsize influence on public policies. While this body of scholarship originates from the U.S., a fast-growing comparative literature extends the U.S. conclusions to Europe. Supposedly, the winner-take-all domination of democratic politics is a global phenomenon.

This paper presents an original approach to examine political representation and reassess these conclusions. Theoretically, we argue that the electoral incentives of governments to cater to majority interests remain strong, and as a result, governments actively use the levers of the tax-and-transfer system to compensate lower-income groups for rising market inequality. We further argue that the partisanship of the government remains of crucial importance, with left governments responding more strongly to rising inequality than right governments.

Empirically, we examine the expectations using a novel, microsimulation approach. This approach enables us to separate the distributional effects of policy changes from that of structural economic changes, offering us a unique opportunity to study whose interests governments actually seek to represent. Specifically, we leverage the European Union’s tax-benefit microsimulation model, EUROMOD, to estimate the distributional effects of changes to tax-and-transfer policies in all 27 EU member states and the United Kingdom since the mid-2000s.   

Consistent with the theoretical expectations, the results show that in the last two decades governments in most  European countries have implemented progressive changes to their tax-and-transfer system. This result appears to be driven, at least partly, by left governments adjusting tax-and-transfer policies to compensate lower-income groups for rising market inequality. We also observe a strong direct effect of the partisanship of the government, with left governments, again, being particularly responsive to the interests of the poor.

These results have important implications for our understanding of the political economy of 21st century capitalist societies, suggesting that governments in Europe actively use the tax-and-transfer system to help ensure that economic growth is broadly shared. More generally, the results suggest that European democracies are more resilient to rising inequality than acknowledged by previous research.