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The Effects of Tax Policy and Labour Market Institutions on Income Inequality

The purpose of this research is to investigate how labor market institutions and regulations and tax policies effect income inequality across the European member countries. The sample contains the fifteen core European Union (EU) members as well as thirteen Central and Eastern European (CEE) economies which have recently joined. Using fixed and random effect panel models over the sample period 2000–2011 we test the influence of three major tax forms (labor, capital and consumption), social security contributions, and labor market institutions. We demonstrate that the overall social contributions and labor taxes lead to statistically significant improvements in income inequality among EU member states. We conclude that tax policy, specifically the choice of taxes implemented, and labor market institutions, union membership in particular, reduce income inequality in the EU-28 in the observed period.