May 2021

IZA DP No. 14357: Why a Labour Market Boom Does Not Necessarily Bring Down Inequality: Putting Together Germany's Inequality Puzzle

Martin Biewen, Miriam Sturm

After an economically tough start into the new millennium, Germany experienced an unprecedented employment boom after 2005 only stopped by the COVID-19 pandemic. Persistently high levels of inequality despite a booming labour market and drastically falling unemployment rates constituted a puzzle, suggesting either that the German job miracle mainly benefitted individuals in the mid- or high-income range or that other developments offset the effects of the drastically improved labour market conditions. The present paper solves this puzzle by breaking down the observed changes in the distribution of disposable incomes between 2005/06 and 2015/16 into the contributions of eight different factors, one of them being the employment boom. Our results suggest that, while the latter did have an equalising impact, it was partially offset by the disequalising impact of other factors and substantially dampened by the tax and transfer system. Our results point to a strong role of the German tax and transfer system as a distributional stabilizer implying that, if the COVID-19 shock were to persistently reverse all the employment gains that occurred during the boom, this would only have a moderately disequalising effect on the distribution of net incomes.