Policy, Demography, and Market Income Volatility: What Shaped Income Distribution and Inequality in Australia Between 2002 and 2016?

• Published date: 01 March 2021
• Author: Jinjing Li,Hai Anh La,Denisa M. Sologon
• Date: 01 March 2021
• DOI: http://doi.org/10.1111/roiw.12467

© 2020 The Authors. Review of Income and Wealth published by John Wiley & Sons Ltd on behalf of

International Association for Research in Income and Wealth

196

POLICY, DEMOGRAPHY, AND MARKET INCOME VOLATILITY: WHAT

SHAPED INCOME DISTRIBUTION AND INEQUALITY IN AUSTRALIA

BETWEEN 2002 AND 2016?

by JinJing Li* and Hai anH La

NATSEM,Institute for Governance and Policy Analysis,University of Canberra

AND

Denisa M. soLogon

Luxembourg Institute of Social and Economic Research

Isolating the impact of policy, demographic shifts, and market volatility on changes in income inequal-

ity is of great interest to policymakers. However, such estimation can be difficult due to the complex

interactions and evolutions in the social and economic environment. Through an extended decomposi-

tion framework, this paper estimates the effect of four main components (policy, demography, market

income and other factors) on the year-over-year changes in income inequality in Australia between

2002 and 2016. This was a period marked by substantial policy, population, and economic shifts due

to factors such as the mining boom, the global financial crisis and increasing immigration. The frame-

work also incorporates a flexible non-parametric market income model which captures demand-side

shock better than a standard parametric model. Our results suggest that market income was the pri-

mary driver of income inequality for all segments of the income distribution in Australia over the

past 15years. Policy factors, moreover, have had the largest net impact on reducing inequality overall,

especially for lower income earners.

JEL Codes: D31, H23

Keywords: ageing, inequality decomposition, policy reform, STINMOD+

1. introDuction

Policymakers are often interested in understanding the contribution of policy,

demographic shifts, and market income volatility on changes in income distribu-

tion, given that social inequality has been shown to have an impact on growth and

social cohesion, both in the short and long run (Wilkinson and Pickett, 2009).

However, such estimation is often difficult due to the complex interactions and

evolutions in the social and economic environment. By extending the decompo-

sition framework suggested by Bourguignon et al. (2008), Bargain and Callan

(2010), Biewen and Juhasz (2012), Bargain et al. (2015) and Sologon et al. (2018),

we explore the year-on-year changes in the Australian income distribution over

15years and identify what drives changes in income inequality. These potential

*Correspondence to: Jinjing Li, NATSEM, Institute for Governance and Policy Analysis,

University of Canberra (Jinjing.Li@canberra.edu.au).

Review of Income and Wealth

Series 67, Number 1, March 2021

DOI: 10.1111/roiw.12467

This is an open access article under the terms of the Creative Commons Attribution License, which

permits use, distribution and reproduction in any medium, provided the original work is properly

cited.

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Review of Income and Wealth, Series 67, Number 1, March 2021

197

© 2020 The Authors. Review of Income and Wealth published by John Wiley & Sons Ltd on behalf of

International Association for Research in Income and Wealth

drivers include not only policy reforms in the tax and transfer system but also

fluctuations in market income (wage and non-wage), variations in employment,

occupation and industry, and shifts in demography and household composition.

Australia has experienced some significant externally driven shocks, such as the

mining boom and the global financial crisis, over the past decade. Demographically,

population ageing, together with an increasing number of migrants, adds a com-

plex mixture to the study of the income distribution over time. Throughout the

past decade in Australia, growing attention in both public discourse and the aca-

demic literature has been paid to income inequality (Johnson and Wilkins, 2004;

Atkinson and Leigh, 2007; Wilkins, 2014, 2015) as well as to the role of tax and

transfer reforms in mitigating inequality (Creedy and Hérault, 2015; Hérault

and Azpitarte, 2015, 2016). Despite this growing interest, however, few empirical

papers exist in Australia systemically examining the drivers of income inequality

over time.

Earlier studies on Australia’s income inequality tend to focus solely on the

period before and during the global financial crisis in 2007–09. For instance,

Hérault and Azpitarte (2015) examine the trends in the redistributive impact of

the tax-benefit system in Australia between 1994 and 2009, while Hérault and

Azpitarte (2016) investigate the role of tax-transfer policy reforms on income

inequality over the 1999–2008 period and Creedy and Hérault (2015) study the

period from 2000 to 2006. Our study adds to the understanding of the primary

factors driving changes in income inequality in Australia between 2002 and 2016,

covering both the pre- and post-crisis phases. It introduces several methodological

refinements, described below, including the use of a non-parametric approach to

generate the counterfactual annual income distribution and a more accurate policy

effect assessment using annual data.

As suggested by the mixed results from European decomposition studies, the

role of tax-transfer policy reforms may change during and after the financial cri-

sis in 2007–09. For example, recent findings in Europe on the decomposition of

changes in the income distribution following the global financial crisis illustrate

that, across 27 European Union (EU) countries, the key drivers influencing inequal-

ity were changes in market income and population characteristics, with an inequal-

ity-increasing effect, while tax and transfer policies more often reduced inequality

(e.g. Paulus and Tasseva, 2017). Similar findings of the inequality-buffer effects of

tax-transfer systems have also been found among OECD countries (Jenkins et al.,

2011) and in various European economies (Brewer et al., 2012; Matsaganis and

Leventi, 2014; Sologon et al., 2018). However, Bargain et al. (2017) found mixed out-

comes when investigating the role of tax-benefit policies in income distribution vari-

ations in four European countries during and after the Great Recession (2008–13).

They observe that during the first stage (2008–10), the policy reaction helped

stabilize or reduce inequality and poverty in France, the U.K., and Ireland but

pushed up poverty rates in Germany when combined with market income changes.

Variations in market income (e.g. job losses or wage cuts) also increased France’s

income inequality and poverty rate. By the later stage of the crisis (2010–13), pov-

erty lessened in France thanks to subsequent policy reforms but rose in Ireland

and varied for different subgroups in the U.K. and Germany due to regressive tax

policy and slow increases in social benefits among the poorest groups.