Analysing the E¤ects of Tax-benet Reforms on Income Distribution: A Decomposition Approach

To assess the impact of tax-bene…t policy changes on income distribution over time, we suggest a methodology based on counterfactual simulations. We start by decomposing changes in inequality/poverty indices into three contributions: reforms of the tax-bene…t structure (rules, rates, etc.), changes in nominal levels of market incomes and tax-bene…t parameters (bene…t amounts, tax bands, etc.), and all other changes in the underlying population (market income inequality, demographic composition, employment level, etc.). Then, the decomposition helps to extract an absolute measure of the impact of tax-bene…t changes on inequality when evaluated against a distributionally-neutral benchmark, i.e. a situation where tax-bene…t parameters are adjusted in line with income growth. We apply this measure to assess recent policy changes in twelve European countries. Finally, the full decomposition allows quantifying the relative role of policy changes compared to all other factors. We provide an illustration on France and Ireland and check the sensitivity of the results to the decomposition order. Key Words : Tax-bene…t policy, inequality, poverty, decomposition, microsimulation. JEL Classi…cation : H23, H53, I32 Acknowledgement: We are grateful to Tony Atkinson and Brian Nolan for useful comments. We are indebted to all past and current members of the EUROMOD consortium as well as to those involved in the development of the model. Any remaining errors, results produced, interpretations or views presented are the authors’ responsibility. Simulations performed in this study rely on national micro-data sets and on the European Community Household Panel (ECHP) for Austria, Denmark, Greece, Portugal and Spain. The Austrian version of the ECHP is made available by the Interdisciplinary Centre for Comparative Research in the Social Sciences; the Panel Survey on Belgian Households is made available by the Universities of Liège and Antwerp; the Income Distribution Survey is made available by Statistics Finland; the public use version of the German Socio Economic Panel Study is made available by the German Institute for Economic Research (DIW), Berlin; the Survey of Household Income and Wealth is made available by the Bank of Italy; the Family Expenditure Survey (FES) is made available by the UK O¢ ce for National Statistics (ONS) through the Data Archive. Material from the FES is Crown Copyright and is used by permission. Neither the ONS nor the Data Archive bear any responsibility for the analysis or interpretation of the data reported here. An equivalent disclaimer applies for all other data sources and their respective providers cited in this acknowledgement. Correspondence to: Olivier Bargain, UCD, Newman Building, Dublin 4, Ireland. Phone: +35317168357. Email: [email protected]