Essays on income inequality and financial incentives to work

This dissertation is about income inequality and financial incentives to work and it aims to take part to a long-lasting discussion about the equity-efficiency trade-off. It consists of an introductory chapter and three separate essays. The introductory chapter discusses income inequality and financial incentives to work in a broader sense and provides a background for the essays. Then the first essay focus solely on income inequality and analyses how changes in demographics and in tax-benefit legislation have shaped the income inequality in Finland. Second essay analyses how the recent changes in the Finnish tax-benefit system affected the income inequality and financial incentives to work in non-behavioural and behavioural settings using microsimulation. Third essay studies the link between health and reactions to financial incentives in the context of Finnish 2005 pension reform. The aim of the first essay is to account the determinants shaping the evolution of income inequality in Finland from 1993 to 2014. It introduces a new decomposition technique which combines microsimulation based decomposition with multivariate regression based decomposition into a unified framework. The new technique allows analysing how the policy changes have affected the importance of different individual characteristics in income inequality. The main findings are that the changes in the importance of the characteristics on income (i.e. price effect), the changes in the distribution of the characteristics (i.e. quantity effect) and the residual effect have contributed to the change in income inequality. Changes in the tax-benefit legislation have also increased the inequality, but since 2005 those have equalized the income distribution. In addition, prior 2005 policy changes explained around 2/3 of the total price effect. The second essay analyses the changes in the tax-benefit legislation, which came into force at the beginning of 2020 in Finland. The main contribution of the essay is that it illustrates a transparent procedure to account for the behavioural responses of the tax-benefit changes in the distributional analysis. Instead of using structural labour supply model, the approach utilizes externally estimated labour supply elasticities. Furthermore, the behavioural responses are, for the first time in Finland, analysed also at the intensive margin. The results indicate that the changes in the tax-benefit system mildly decreased income inequality but also weakened the financial incentives to work at both margins. However, any Covid19 related changes in demographics or in politics could not be taken into account and therefore the result should be viewed cautiously. Third essay studies the link between financial incentives and health in the context of 2005 Finnish pension reform. It utilizes a rich register data of pensions and health and the exogenous variation in retirement incentives created by the reform. The focus of the essay is on how health and reactions to incentives interact. The findings are that stronger incentives to continue working postpone retirement while the larger level of pension wealth increases the likelihood of retirement. Furthermore, ill-health was found to increase the risk of retirement. The results also suggest that many types of individuals, with different health statuses, are reacting to the incentives with an expected manner