The Role of Market Income, Taxes, and Subsidies in Income Inequality in Iran: A Microdata Analysis (2011-2023)

Extended Abstract
 
Introduction and Objectives: Income inequality has emerged as a critical challenge for many developing economies, including Iran, where disparities in income distribution can have significant socio-economic consequences. In this context, government policies such as taxes and subsidies are central instruments that can influence the degree of inequality within society. Taxes provide the financial resources necessary to fund social programs and subsidies, while subsidies themselves aim to redistribute income more equitably, particularly to support lower-income households. The interplay between these two instruments, commonly referred to as the tax-subsidy cycle, has the potential to reduce income disparities, improve living conditions for vulnerable groups, and enhance their participation in economic and social life. Understanding the effectiveness of these instruments is essential for policymakers, as it informs whether the intended reforms are achieving their redistributive goals and what potential future adjustments could yield in terms of inequality reduction.
This study aims to provide a comprehensive, micro-level analysis of the determinants of income inequality in Iran, focusing on three main components: primary market income, taxes, and subsidies. While previous research has largely focused on macro-level data, there is a notable gap in the literature regarding micro-level household analysis. This study utilizes household-level data from the Iranian Household Income and Expenditure Survey (HIES) for the period 2011 to 2023 to evaluate the redistributive impact of the existing tax and subsidy system on income inequality. By dissecting the relative contributions of these income components, the study seeks to provide evidence-based guidance for policy formulation aimed at reducing inequality efficiently and sustainably.
Methodology: The analysis relies on raw household survey data from 2011 to 2023 provided by the Statistical Center of Iran. To control for household size and allow for meaningful comparisons across households, the study employs an equivalence scale, dividing total household income by the number of household members to calculate per capita equivalent income. This adjustment ensures that variations in household size do not bias inequality measurements.
The study employs the factor decomposition method developed by Lerman and Yitzhaki (1985) to quantify the contribution of each income source to overall income inequality. The generalized Gini coefficient is decomposed according to income sources (l), allowing for a detailed analysis of the distributive role of market income, taxes, and subsidies.
Additionally, the elasticity of inequality with respect to each income source is calculated, capturing the sensitivity of total income inequality to a 1% change in each income component. Computational implementation involves iterative algorithms, covariance calculations, and cumulative distribution functions to obtain values of Sl, Gl, and Rl for each year and income source.
It is important to note that the factor decomposition performed in this study is cross-sectional for each year, meaning that it evaluates the impact of each income source on measured inequality in a given year. This approach provides insight into the annual redistributive effects of taxes and subsidies, as well as the structural dominance of market income.
Results: The decomposition of the Gini coefficient for the period 2011 to 2023 is presented in Table 1 and illustrated in Figure 1. These results highlight the contribution of each income source to overall inequality. Positive values indicate that the income source increases inequality, while negative values reflect a redistributive effect, reducing the Gini coefficient.
Table 1 – Decomposition of Per Capita Income Gini (2011–2023)




Income Source


Year


Share of Income Source Inequalities in Total Inequality


Year


Share of Income Source Inequalities in Total Inequality


Year


Share of Income Source
Inequalities in Total Inequality




Market income
Subsidies
Taxes
 


2011


0.37
0.009
-0.0132


2016


0.4156
-0.0006
-0.0144


2020


0.42
-0.0014
-0.013




Market income
Subsidies
Taxes
 


2012


0.3686
0.0038
-0.0134


2017


0.4164
-0.0024
-0.0141


2021


0.4193
-0.0028
-0.0145




Market income
Subsidies
Taxes
 


2013


0.3743
0.0035
-0.0143


2018


0.4285
-0.0011
-0.0144


2022


0.4029
-0.0026
-0.0123




Market income
Subsidies
Taxes
 


2014


0.3883
0.001
-0.0143


2019


0.4208
-0.0024
-0.0138


2023


0.397
-0.0063
-0.0146




Market income
Subsidies
Taxes


2015


0.3939
-0.0008
-0.0146


 




 
 
 
 
 
Figure 1: Percentage share of market income, subsidies and taxesin the Gini coefficient of per capita income in 2011-2023
Analysis of the results indicates that subsidies in the early years (2011-2014) contributed positively to income inequality, suggesting that subsidy distribution during this period exacerbated pre-existing disparities in market income. Subsequent reforms, including the removal of subsidies from higher-income households and targeting of lower-income groups, gradually reduced this effect. The declining contribution of subsidies over time reflects a slow but steady shift towards more targeted and efficient redistribution. However, the overall magnitude of the redistributive effect of subsidies remains limited.
Similarly, taxes demonstrate a modest redistributive effect, reducing market income inequality but failing to significantly lower the per capita Gini coefficient. Despite fluctuations in the Gini coefficient due to taxes and subsidies, their overall contribution to reducing inequality is relatively small compared to the dominant role of market income. This finding underscores that the current design and implementation of fiscal policies in Iran do not achieve the expected redistributive outcomes.
Market income consistently accounts for the largest share of overall income inequality, indicating that, in the absence of taxes and subsidies, the Gini coefficient would be substantially higher. To gain a more nuanced understanding, market income is further decomposed into sub-components, including non-employment income, self-employment income (both agricultural and non-agricultural), and wages in public and private sectors (Figure 2).
Figure 2: Percentage share of non-labor income, wage and salary income in the public, private and cooperative sectors, and agricultural and non-agricultural self-employment income in the Gini coefficient of market income in 2011-2023
The decomposition reveals that non-employment income contributes the most to market income inequality, averaging 37.4% of the total. Non-agricultural self-employment income follows with an average contribution of 23%, and public-sector wages account for 22%. These results indicate that structural characteristics of market income, rather than post-market redistributive policies, are the primary drivers of income disparities in Iran.
Discussion and Conclusion: The findings provide critical insights into the limitations of current redistributive policies in Iran. The decomposition of per capita income into market income, taxes, and subsidies demonstrates that these fiscal instruments collectively influence only approximately 3.6% of the Gini coefficient for market income. This modest impact indicates that current fiscal policies exert a limited redistributive effect, highlighting the need for more progressive and effective interventions.
Moreover, the structural dominance of market income as a driver of inequality underscores that the roots of income disparities lie primarily in pre-market mechanisms. The disproportionate contribution of non-employment income suggests that income concentration in certain asset classes is a major source of inequality, and mid-term trends suggest that private-sector wage growth will increasingly shape overall income inequality. Wealth accumulation and the dynamics of compensation in the private sector may exacerbate disparities traditionally associated with the public sector, reinforcing structural inequalities.
The study contributes to the literature by providing robust micro-level evidence of the limited effectiveness of current tax and subsidy policies in addressing income inequality in Iran. By highlighting the structural underpinnings of inequality and the relatively minor role of fiscal instruments, the research informs policymakers that enhancing the redistributive capacity of taxes and subsidies alone is insufficient. Comprehensive reforms addressing the structural sources of market income disparities are required to achieve meaningful reductions in inequality.
In conclusion, while taxes and subsidies have a measurable but limited effect on mitigating income inequality, the dominant influence of market income, particularly non-employment and private-sector wages, emphasizes the need for policies that target structural sources of disparity. Effective redistribution in Iran requires a combination of targeted fiscal interventions and structural economic reforms to reduce inequality sustainably and promote inclusive economic growth.