What explains recent trends in income inequality in the European Union?

Abstract

We investigate trends in income inequality in the European Union (EU) from 2007 to 2019. Using EU-SILC data, we find that EU-wide inequality declined between 9 and 20%, depending on the inequality measure applied, despite rising within-country income inequality during the same period. Applying a series of decomposition techniques, we find that between-country convergence in pre-tax/transfer incomes fully explains the declining EU-wide inequality. Changes in tax and transfer systems, in contrast, contributed to marginally higher inequality in 2019 compared to 2007. Nonetheless, the 10th percentile of the EU-wide income distribution grew six times the rate of the 90th percentile, a product of widespread earnings gains among residents of lower-income EU Member States. Re-centered influence functions and Kitigawa-Oaxaca-Blinder analyses reveal that those earnings gains are not due to specific compositional or employment changes but rather are due to rising earnings returns to employment in lower-income Member States. Despite the contribution of between-country income convergence in reducing EU-wide inequality between 2007 and 2019, however, within-country income disparities continue to explain the larger share of EU-wide inequality levels in 2019. Thus, reducing within-country economic disparities is increasingly important for achieving further reductions in EU-wide inequality moving forward.