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Comparing Welfare Change Measures withIncome Change Measures in Behavioural Policy Simulations

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  • John Creedy
  • Nicolas Herault
  • Guyonne Kalb

Abstract

This paper presents a method of computing welfare changes (compensating and equivalent variations) arising from a tax or social security policy change, in the context of behavioural microsimulation modelling where individuals can choose between a limited number of discrete hours of work. The method allows fully for the nonlinearity of the budget constraint facing each individual, the probabilistic nature of the labour supply model and the presence of unobserved heterogeneity in the estimation of preference functions. An advantage of welfare measures, compared with changes in net incomes, is that they take into account the value of leisure and home production. The method is applied to hypothetical income tax policy changes in Australia and comparisons are made at the individual and the aggregate level. At the aggregate level a social welfare function is specified in terms of money metric utility. It is shown that policy evaluations based on welfare changes can be substantially different from those using only individuals' net income changes.

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Bibliographic Info

Paper provided by The University of Melbourne in its series Department of Economics - Working Papers Series with number 1030.

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Length: 30 pages
Date of creation: 2008
Date of revision:
Handle: RePEc:mlb:wpaper:1030

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Postal: Department of Economics, The University of Melbourne, 5th Floor, Economics and Commerce Building, Victoria, 3010, Australia
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Keywords: Welfare change measures; equivalent variation; compensating variation; labour supplymodelling; nonlinear budget constraint;

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References

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  1. Harvey S. Rosen & Kenneth A. Small, 1981. "Applied Welfare Economics with Discrete Choice Models," NBER Working Papers 0319, National Bureau of Economic Research, Inc.
  2. Jerry A. Hausman, 1983. "Taxes and Labor Supply," NBER Working Papers 1102, National Bureau of Economic Research, Inc.
  3. Binh, Tran Nam & Whiteford, Peter, 1990. "Household Equivalence Scales: New Australian Estimates from the 1984 Household Expenditure Survey," The Economic Record, The Economic Society of Australia, vol. 66(194), pages 221-34, September.
  4. Creedy, J., 1997. "Measuring Welfare Changes and the Excess Burden of Taxation," Department of Economics - Working Papers Series 587, The University of Melbourne.
  5. John Creedy & Guyonne Kalb, 2003. "Discrete Hours Labour Supply Modelling: Specification, Estimation and Simulation," Treasury Working Paper Series 03/20, New Zealand Treasury.
  6. Johansson,Per-Olov, 1987. "The Economic Theory and Measurement of Environmental Benefits," Cambridge Books, Cambridge University Press, number 9780521348102, November.
  7. Latham, Roger W, 1980. "Quantity Constrained Demand Functions," Econometrica, Econometric Society, vol. 48(2), pages 307-13, March.
  8. Duncan, Alan & Weeks, Melvyn, 1997. "Behavioural tax microsimulation with finite hours choices," European Economic Review, Elsevier, vol. 41(3-5), pages 619-626, April.
  9. Guyonne Kalb, 2002. "Estimation of Labour Supply Models for Four Separate Groups in the Australian Population," Melbourne Institute Working Paper Series wp2002n24, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne.
  10. Guyonne Kalb & Rosanna Scutella, 2002. "Estimation of Wage Equations in Australia: Allowing for Censored Observations of Labour Supply," Melbourne Institute Working Paper Series wp2002n08, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne.
  11. Ian Walker & Ian Preston, 1999. "Welfare measurement in labour supply models with nonlinear budget constraints," Journal of Population Economics, Springer, vol. 12(3), pages 343-361.
  12. John Creedy & Guyonne Kalb, 2005. "Measuring Welfare Changes In Labour Supply Models," Manchester School, University of Manchester, vol. 73(6), pages 664-685, December.
  13. Hausman, Jerry A, 1981. "Exact Consumer's Surplus and Deadweight Loss," American Economic Review, American Economic Association, vol. 71(4), pages 662-76, September.
  14. M. Keane & R. Moffitt, . "A structural model of multiple welfare program participation and labor supply," Institute for Research on Poverty Discussion Papers 1080-96, University of Wisconsin Institute for Research on Poverty.
  15. John Creedy & Guyonne Kalb & Hsein Kew, 2001. "The Melbourne Institute Tax and Transfer Simulator (MITTS)," Melbourne Institute Working Paper Series wp2001n16, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne.
  16. Neary, J.P & Roberts, K.W.S, 1978. "The Theory of Household Behaviour under Rationing," The Warwick Economics Research Paper Series (TWERPS) 132, University of Warwick, Department of Economics.
  17. Creedy, J., 2001. "Quadratic Utility, Labour Supply and The Welfare Effects of Tax Changes," Department of Economics - Working Papers Series 774, The University of Melbourne.
  18. Creedy, John & Duncan, Alan, 2002. " Behavioural Microsimulation with Labour Supply Responses," Journal of Economic Surveys, Wiley Blackwell, vol. 16(1), pages 1-39, February.
  19. Richard Blundell & Alan Duncan & Julian McCrae & Costas Meghir, 2000. "The labour market impact of the working families’ tax credit," Fiscal Studies, Institute for Fiscal Studies, vol. 21(1), pages 75-103, March.
  20. Apps, Patricia & Rees, Ray, 1999. "On the taxation of trade within and between households," Journal of Public Economics, Elsevier, vol. 73(2), pages 241-263, August.
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Cited by:
  1. Iris Claus & John Creedy & Josh Teng, 2010. "The Elasticity of Taxable Income in New Zealand," Department of Economics - Working Papers Series 1104, The University of Melbourne.
  2. John Creedy & Nicolas Herault & Guyonne Kalb, 2008. "Abolishing the Tax-Free Threshold in Australia: Simulating AlternativeReforms," Department of Economics - Working Papers Series 1048, The University of Melbourne.

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