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International Tax and Public Finance

Erschienen in:

24.04.2019

Which households matter most? Capturing equity considerations in tax reform via generalised social marginal welfare weights

verfasst von: David Madden, Michael Savage

Erschienen in: International Tax and Public Finance | Ausgabe 1/2020

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Abstract

Social marginal welfare weights reflect the values of the social planner, or equivalently the underlying social welfare function, when evaluating the welfare impact of a change in public policy such as a tax reform. Using the nationally representative Irish Household Budget Survey, we empirically examine the sensitivity in the distribution of welfare weights to applying alternatives to the commonly employed “default” of Utilitarianism. The alternative weighting schemes we analyse are based upon: the principles of Equal Sacrifice, poverty alleviation, government self-interest and the distinction between deserving and undeserving income. We first examine the correlation between these welfare weights and the underlying measure of household resources. Then, applying these alternative welfare weights to a commonly used indirect tax reform model, the ranking of goods by distributional characteristic, the component of the model capturing distributional concerns, is shown to be highly sensitive to the choice of welfare weights. This sensitivity does not persist when demand responses are also incorporated.

Vorheriger Artikel Intergovernmental revenue relations, tax enforcement and tax shifting: evidence from China

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Although our discussion here is in terms of individuals, the data used in the analysis below are available only at household level. While we apply conventional equivalence scales to adjust for different household size and composition, we ignore issues of within-household distribution.

It is worth noting that some characteristics such as fairness and health/disability can also be incorporated in a welfarist setting (see Fleurbaey and Maniquet 2018; Jones and O’Donnell 1995). We are grateful to an anonymous referee for pointing this out.

It is arguable that governments are most likely to focus their attention on swing voters, those who might be persuaded from not voting to voting, or those who might be persuaded to switch parties. Unfortunately, our data do not permit us to identify these individuals, but we are grateful to an anonymous referee for raising the point.

Note, however, that there is a literature on non-welfarist tax design e.g. Kanbur et al. (1994). We are grateful to a referee for pointing this out.

We outline what exactly we mean by deserved income below.

We are grateful to an anonymous referee for pointing this out.

Household disposable income, equivalised using a scale of 1 for the first adult, 0.66 for subsequent adults, and 0.33 for children. This is the scale used by the Central Statistics Office (CSO) of Ireland. Results based upon expenditure available on request.

The Lorenz curve is a special case of a concentration curve where the ranking variable on the horizontal axis is the same as the variable of interest on the vertical axis.

See Appendix for a detailed guide on interpretation of the concentration curves.

We measure only the VAT and excise duty payments made by a household. Smaller indirect tax schemes, such as the air travel tax, are omitted. See Collins and Turnbull (2013) for an approach that attempts to measure such smaller indirect tax payments.

We are grateful to Sean Lyons for help identifying the relevant VAT rate on each expenditure component in the HBS.

The standard tax rate was reduced from 21.5 to 21% in Budget 2010. We assume the 21% rate applied to all expenditure in the survey, although some will have been taxed at the higher 21.5%. More recently, the standard VAT rate in Ireland was increased to 23%.

The two tax columns can be interpreted as average tax rates (direct and indirect) for each decile.

Savage and Callan (2015), Collins and Turnbull (2013) and Leahy et al. (2011) find a similar pattern of tax payments by decile in Ireland.

Our default specification here is \( \phi = 1 \) as it allows for the weight to increase with higher tax payments at a constant rate. Obviously, an increasing or decreasing rate could be incorporated via different values of \( \phi \).

An extension of this measure might be to include the value of public goods consumed. However, it is unclear if the consumption of public goods should be included here. With pure public goods, one household’s consumption will not affect another household’s consumption. This distinction is not as clear with semi-public goods or non-marketed services provided by the state such as education. Either way, the HBS data in this paper do not identify public goods consumption, so we do not include them in our measure of \( t^{\text{h}} \) and leave analysis of this issue to future research.

Negative welfare weights imply any tax optimum is constrained Pareto efficient (see Saez and Stantcheva 2016).

The majority of households in the bottom deciles will not have income high enough to be liable for direct taxation, so patterns of welfare receipt explain the majority of differences for these deciles.

For example, previously self-employed individuals may have reduced eligibility for unemployment supports due to a lack of social insurance contributions.

Based on the findings of Brewer et al. (2017), this phenomenon may also be due to misreporting of income in the bottom decile.

As a further example, see the Irish Department of Social Protection’s Social Impact Assessment of Budget 2013, which explicitly includes the impact of Budget 2013 on the poverty rate (Department of Social Protection, 2013).

\( g^{h} = 0 \) otherwise.

z, measured as 60% of median disposable income, is located in the second decile.

We can restrict \( \beta^{h} > 0 \) to households with children if we are most concerned about child poverty—see Appendix for the distribution of weights in this scenario.

See Appendix for discussion of an alternative method of identifying “luck” income, where income from property and investments is considered to be due to “luck” rather than effort. However, as the 2009/2010 Irish HBS contains relatively little income from these sources (likely in part to the fact that Ireland was in deep recession at the time), removing the luck element of income defined in this way has virtually no impact on the distribution of income. Therefore, specifying weights as a function of “luck” and “deserved” income categorised in this way is unlikely to produce a profile of weights that differ appreciably from the standard welfarist weights.

Of course hours of work can also vary within a household. However, due to the nature of the HBS data we do not take account of this within-household variation.

We are grateful to an anonymous referee who suggested a utility function of this form.

Lifecycle issues may again be important here, as higher educated households would likely have had periods of lower income while acquiring education, while households that currently have zero hours of work (for example retired households, households containing unemployed individuals) may have a high number of hours of work in another period.

Note that in the expression in Eq. 10 we accord equal importance to weights arising from income and those arising from hours. This arises from the additive separability of the utility function in (8). We are grateful to an anonymous referee for drawing our attention to this point.

Alesina and Angeletos (2005) show that under certain circumstances the optimal tax rate chosen by a planner with a weighted utilitarian welfare function and a probabilistic voting model is equivalent.

For simplicity, we take the government and policy maker as one individual decision-making unit. In reality, of course multiple decision makers exist within most governments and so each may use a different distribution of welfare weights when making decisions. In addition, the electoral and decision-making rules may affect the policy decisions made in government (Suiter and O’Malley 2013), while other models of government decision making suggest the primary aim is to build a bureaucratic empire rather than gain re-election. It is beyond the scope of this paper to address these concerns.

This reflects the absence of a major election in 2009/2010 rather than a shortcoming of the data collectors.

Note that in the context of optimal tax design under certain circumstances policy makers need only rely on an optimal nonlinear income tax in order to obtain both equity and efficiency goals (Atkinson and Stiglitz 1976). We are grateful to an anonymous referee for pointing this out.

The ten goods are food, alcohol, tobacco, clothing, fuel, household non-durables, household durables, housing, transport, and services and other goods.

The actual rankings are provided in Table 5 of Appendix.

Increasing the value of e in the Utilitarian weights maintains the high correlation coefficient as \( \alpha \) increases in the poverty-based weights.

Demand responses used here are estimated via the QUAIDS specification of the underlying demand system, including a range of demographic information, using HBS data from 1987 to 2009. While the distributional characteristic analysis was based on 10 aggregated goods, the requirement to estimate own-price and cross-price elasticities for each good meant that expenditure items in the HBS were aggregated into 6 representative goods when estimating demand responses. The sensitivity of the MRC rankings is therefore based on 6 goods rather than 10. The actual demand elasticities are provided in Table 4 of Appendix.

The scale elasticity can be interpreted as the relative change in the demand price of commodity j due to a 1% increase in the Divisia quantity index \( \sigma \sum\nolimits_{j} {w_{j} d\log x_{j} } \)

Demerit parameter set at 0.7 following Savage (2016), where further information and discussion can be found.

We follow O’Donnell et al.’s (2008) method of graphing concentration curves in Stata.

Having disposable income on the x-axis can be seen as setting the Utilitarian case with disposable income as the measure of resource as our “base” case. The concentration curves then show how each alternative differs from this base case.

A tax which is paid upon the sale of an asset such as property.

An assumption of full shifting may not be unreasonable even without such simplifying assumptions about the production side of the economy. See Myles (1987), Delipalla and O’Donnell (2001) and Fullerton and Metcalf (2002) for analysis of tax shifting under imperfect competition.

Again, these estimates are drawn from Savage (2016), where further details of the QUAIDS model and the demographic variables included in the model can be found.

As well as being subject to the standard rate of VAT, it is also subject to excise duties.

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Titel: Which households matter most? Capturing equity considerations in tax reform via generalised social marginal welfare weights
verfasst von: David Madden
Michael Savage
Publikationsdatum: 24.04.2019
Verlag: Springer US
Erschienen in: International Tax and Public Finance / Ausgabe 1/2020
Print ISSN: 0927-5940
Elektronische ISSN: 1573-6970
DOI: https://doi.org/10.1007/s10797-019-09543-y

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