Why has Income Inequality in Germany Increased From 2002 to 2011? A Behavioral Microsimulation Decomposition

Abstract

This paper proposes a method to decompose changes in income inequality into the contributions of policy changes, wage rate changes, and population changes while considering labor supply reactions. Using data from the Socio‐Economic Panel (SOEP), this method is applied to decompose the increase in income inequality in Germany from 2002 to 2011, a period that saw tax reductions and a controversial overhaul of the transfer system. The simulations show that tax and transfer reforms have had an inequality‐reducing effect as measured by the mean log deviation and the Gini coefficient. For the Gini, these effects are offset by labor supply reactions. In contrast, policy changes explain part of the increase in the ratio between the 90th and the 50th income percentiles. Changes in wage rates have led to a decrease in income inequality. Thus, the increase in inequality was due to changes in the population.

Why Did Income Inequality in Germany Not Increase Further After 2005?

“…As in our simulations of the transfer system, we do not consider potential behavioural reactions to tax changes in this way. However, given the evidence in Jessen (2016), and given that the mechanical effects on the income distribution are already very small, it is unlikely that incorporating behavioural reactions would change any of our results.…”

“…given the relatively small effects and given the fact that behavioural reactions often tend to counteract the original effects (e.g., Jessen, 2016), we would not expect that taking account of behavioural reactions would change any of our results.…”

“…There are only a few contributions that adopt a more analytic approach to changes in the German income distribution, see in particular Peichl et al . () and Jessen (). For a comprehensive overview of a number of relevant developments in the German income distribution, see Corneo ().…”

“…Grabka et al (2012), Grabka and Goebel (2013), Schmid and Stein (2013), Sachverst€ andigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung (2011Entwicklung ( , 2015, Feld and Schmidt (2016) and Battisti et al (2016) document and discuss a number of relevant trends in the distribution of equivalized net incomes but do not explicitly model their potential influence on the distribution. There are only a few contributions that adopt a more analytic approach to changes in the German income distribution, see in particular Peichl et al (2012) and Jessen (2016). For a comprehensive overview of a number of relevant developments in the German income distribution, see Corneo (2015).…”

“… Note that this analysis does not consider potential behavioural adjustments to the changes in the transfer system. However, given the evidence in Jessen () such potential behavioural reactions appear to be rather small and would generally counteract the direct effects on incomes. …”