Cost of living and its relevance for economic inequality: an admin-data approach studying the Swiss case

In affluent countries, cost of living is an important component to assess economic possibilities of its population. However, in inequality studies this component is mostly neglected. At the same time, it seems clear that economic well-being is determined more by disposable income after basic needs are considered than by income earned exclusively. In this paper we develop a procedure to determine the impact of the cost of living on inequality of disposable incomes after cost of living. This includes spending on everyday goods, housing costs, health insurance premiums and taxes. These are the major unavoidable cost components that occur in Switzerland. To quantify the magnitude of costs of living on disposable income inequality we build upon a framework promoted by Reynolds and Smolensky (1977) that is widely used in distributional studies. For empirical analysis we use linked tax data that comprehensively depict the financial situation of about 3.5 million people in Switzerland. To model cost of living, we consider different scenarios, including minimum level of subsistence and average expenditures. Comparing the income distribution before costs we find an increase from 31.3 Gini-Points (GP) to 42.2 (+10.9) using minimum and 57.2 (+15.9 GP) using average costs. Overall, considering everyday goods (+5.7 GP to +15.5 GP) and the costs of housing (+6GP to +10.8 GP) are particularly noticeable. The cost of health insurance premiums are also associated with an increase in inequality (+3.7 GP to 4.7 GP), even when the equalizing effect of the premium reductions system is included (-0.8 GP to -0.9 GP), that is especially designed to support low-income groups. In contrast, progressive taxes significantly reduce income inequality (-3.7 GP to -4.2 GP). The analyses also show that the cost-of-living effects diverge particularly strongly for the poorest and wealthiest 10% of the income distribution. Although the highest-income group is disproportionately burdened by taxes, they are hardly affected by daily cost-of-living. In contrast, the two lowest-income groups are affected to a strikingly high degree. In the “average cost” scenario, 20% of the population could not afford necessary expenses. Finally, regional differences in cost of living do increase inequality in disposable incomes between cantons (+1.9 GP). This effect is largely due to different implementations of welfare instruments like taxes and the cost of health care premiums, while cost for daily expenses and houses affect the income distribution withing cantons similarly across cantons.