Association for Public Policy Analysis & Management

Historically, income redistribution was thought to be the primary way to reduce income inequality, yet recent studies show that increasing redistribution can actually lead to higher levels of inequality. Welfare is both a solution to reducing inequality as well as a response to rising inequality. There are numerous variables that may undermine the ability of government redistribution to impact inequality. For instance, employment and wages are key factors in for increasing the income share of the bottom sector in society and as employment declines inequality will necessarily increase, holding other things constant.The underlying causes of the inequality as well as the reasons for rising redistribution will decide if social spending will be effective for reducing inequality. Social Spending will be more effective when it targets the main poverty demographics. For example, in the United States, the bottom quintile is mainly young families, therefore raising benefits such as TANF (Temporary Assistance for Needy Families) will be more effective than programs that help the elderly. This paper investigates the relationship between inequality and income redistribution through two case studies in the United States and Luxembourg, as well as regressions with panel data and a simultaneous equations model for 34 OECD countries over various years between 1995 and 2011. In the simultaneous equations model, the data shows that rising social spending can increase inequality and that rising inequality triggers increased social spending. The panel data model shows that welfare payments reduce inequality up to a point, with spending on families being more effective than general social spending, but also shows that as welfare spending increases, eventually inequality will increase as well.  Social spending does not automatically reduce income inequality and will need to be tailored to this specific goal in order to be effective.