Distributional Effects of Fiscal Policy Measures during the Corona Pandemic

Tasks

The Corona pandemic and the associated health policy restrictions led to drastic negative economic impacts. This was associated with effects on disposable incomes and additional financial burdens on households. To counteract such negative shocks, the federal government adopted a variety of fiscal support measures that addressed both supply- and demand-side transmission channels of the economy and were designed to cushion a loss of income on the household side. For instance, the stimulus package included tax cuts, government transfers and subsidies whose effects differ for different individuals, such as workers or families and households without children. Accordingly, one may well expect that the distributional impact of the stimulus program was not uniform, but that individuals were affected by the policy measures to different degrees. Corona emergency assistance measures and the stimulus program were likely to have asymmetric effects on household income and consumption.

A well-founded quantification of fiscal policy distributional effects is of interest for an effective design of fiscal policy, especially against the background of the heterogeneous impacts of the instruments. Often, the instruments adopted are aimed specifically at certain groups, but their actual effectiveness can only be assessed through quantitative analysis. Against the background of the ongoing crisis, knowledge of distributional effects is an important prerequisite for the proper design of possible fiscal policy measures in the coming months. Undesirable economic effects, such as excessive burdening or even unintended fiscal relief for certain groups, can be identified and highlighted by analyzing distributional effects.

We examined the effects of two temporary fiscal policy instruments adopted by the federal government as part of the stimulus package during the Corona pandemic. The measures considered are (i) the payment of the child bonus and (ii) the temporary reduction in VAT. Broken down by different household types, the effects on household income, consumption expenditure, and poverty and inequality measures were presented.

Methods

ifo Microsimulation Model ifo-MSM-TTL

Data and other sources

Socio-Economic Panel (SOEP) from 2018 (v35), Income and Consumption Survey (EVS) from 2018

Results

The child bonus significantly increased average household income and consumption expenditures compared to a baseline scenario without reform measures. For households in the first income decile, the child bonus resulted in an increase in income of about 1.2 percent and in consumption expenditure of about 0.9 percent compared with the baseline scenario. In the third income decile, the values are 0.6 and 0.4 percent. Only from the eighth income decile onwards are the relative increases in income and consumption below 0.1 percent. Thus, lower- and middle-income families, who were and are particularly burdened by the Corona crisis, are relatively better off.

The empirical question of the extent to which the temporary reduction in sales tax rates was passed on to final consumers has not yet been conclusively clarified. Two scenarios were considered that span a possible corridor: On the one hand, it was assumed that the sales tax cuts would be passed on to consumers in full, and on the other hand, that half of the cuts would be passed on to consumers. By assumption, the sales tax cuts have no impact on average household incomes in the model, but they do influence households' consumption options. If the tax cut is passed on in full, average consumption increased by 0.9 percent in each household in 2020, compared to about 0.4 percent if it was passed on in half. Single people, single parents, and households with no or one child, as well as households in the lower income deciles, benefitted with the largest relative increase in consumption spending.  The consumption adjustments from the sales tax cuts represent a lower bound.

In a final step, the combined distributional effects of the payment of the child bonus and the temporary sales tax cuts were considered. If the tax cut was passed on in full, consumption increased by 1.1 percent along with the child bonus in the model; if it is passed on in half, consumption increased by 0.6 percent. Among average household types, the consumption effects were largest for single parents, at 2.1 and 1.6 percentage points, respectively. Households with three children benefitted the most, as expected, with consumption gains of 2.1 and 1.7 percentage points. When distinguishing between income deciles, households in the first decile could increase their consumption most substantially compared with the baseline scenario, by 1.8 and 1.4 percentage points.

The reform measures also contributed to an improvement in inequality and poverty measures. The Gini coefficient decreased by 0.2 percentage points in terms of household income. The poverty risk ratio fell by 0.4 percentage points as a result of the child bonus, despite an increase in median income, and the child poverty risk ratio fell by 1.5 percentage points. Relative to income, the P90-P10 ratio decreased by 0.038. Relative to consumption, the P90-P10 ratio decreased by 0.024 with the child bonus and a half pass-through of the sales tax cuts, and by 0.026 with a full pass-through. Relative to the poverty and inequality measures, it appears that the child bonus was an effective transfer for the distributional objective of providing financial relief to low- and middle-income families. Due to the temporary nature of the child bonus, it is unlikely to have any significant positive or negative labor supply effects.