How Accurate is the Kakwani Index in Predicting Whether a Tax or a Transfer is Equalizing?

An Empirical Analysis

Abstract

The Kakwani index of progressivity is commonly used to establish whether
the effect of a specific tax or transfer is equalizing. In the presence of
reranking or Lambert’s conundrum, however, a progressive tax could be
unequalizing. While it is mathematically possible for counter-intuitive
results to occur, how common are they in actual fiscal systems? Using a
novel dataset that includes fiscal-incidence results for 39 countries, we find
that the likelihood of the Kakwani index to be progressive (regressive),
while the tax or transfer is unequalizing (equalizing), is minimal, except in
the case of indirect taxes: in roughly 25 per cent of our sample, regressive
indirect taxes are equalizing (sign-inconsistent cases). Additionally, the
likelihood that the Kakwani index ranks the magnitude of the impact of a
tax or transfer wrongly also exists but it too is small. Finally, using
regression analysis, we find that increasing the size or progressivity of a
progressive tax or transfer is equalizing and statistically robust for
sign-consistent cases. For sign-inconsistent cases, the coefficient for the
Kakwani index is not statistically significant. In sum, although the
Kakwani index could yield interpretations that are inaccurate in actual
fiscal systems, the risk seems small, except for indirect taxes.