Tax and Transfer System: Current Redistribution Mainly through Social Insurance

Press Release of February 18, 2015

The German tax and transfer system ensures that the net incomes of its citizens are distributed much more evenly than market income. Much of this redistribution takes place through the social security system. However, the majority of government benefits do not go to financially needy households. Tax expert Stefan Bach summarizes the key findings of a recent study conducted by the German Institute for Economic Research (DIW Berlin): “While income is properly redistributed in Germany, apart from basic social security, many transfers also go to middle-class or even to wealthy citizens.”

Keyword SOEP

The Socio-Economic Panel (SOEP) study is the largest and longest-running multidisciplinary longitudinal study in Germany. The SOEP is located at DIW Berlin and funded by the federal and state governments as part of Germany's research infrastructure under the umbrella of the Leibniz Association (WGL). Since 1984, the survey institute TNS Infratest has surveyed several thousand people annually for SOEP. There are currently about 30,000 respondents in approximately 15,000 households. The SOEP data include information on income, employment, education, health, and life satisfaction. Since the same individuals are surveyed each year, SOEP can not only identify long-term social trends but is also able to analyze in detail the group-specific development of individuals' lives.

By international standards, Germany is a country with a high degree of income redistribution - mainly because of its broad-based social security systems which not only combat poverty but also ensure acceptable standards of living in old age or when citizens are sick or unemployed. Consequently, they also go to citizens not entitled to basic benefits. Government transfers are the largest item in the budget; about 18 percent of gross domestic product (GDP) is spent on these annually.

Stefan Bach, Markus Grabka, and Erik Tomasch from DIW Berlin have examined the effects of government redistribution policy using data from the household survey Socio-Economic Panel (SOEP) study from 2011. To what extent is income inequality reduced by the tax and transfer system, and how well targeted are the transfers? Only monetary redistribution was considered. Non-monetary social benefits such as public health services were not part of the study.

Researchers sorted the population in ascending order according to level of annual household income and divided them into ten equal groups (deciles). As expected, the inequality of market income, i.e., earned and capital income was highest; in this case, the Gini coefficient, an internationally recognized measure of inequality was 0.5. After transfers, taxes, and social security contributions, the distribution of disposable household income is considerably more uniform than the distribution of market income, resulting in the Gini coefficient decreasing to 0.29. As a result of the redistribution, disposable income increases compared to market income among the lower income groups, whereas in the top deciles it increasingly declines. “On balance, the poorer half of the population receive something from the government, while the richer half pay money to the government,” said Stefan Bach.

The largest share of government transfer payments - in macroeconomic terms - is statutory pension insurance. However, in the long-term, it contributes comparatively little to the redistribution, insofar as citizens have paid equivalent contributions for these benefits in the past. Here, only the share of benefits financed through taxes (federal grants) is relevant for the redistribution.

Basic social security benefits such as unemployment benefit II (Hartz IV) and the basic pension, both of which benefit those in need, have a high redistributive effect. Other transfers like family-related benefits, child benefit in particular, are paid regardless of financial circumstances and across all income groups. Therefore, they have barely any redistributive effect among the income groups.