A social welfare model for the evaluation of the spanish income tax system

In this paper we present a social welfare model for the evaluation of the Spanish income tax system in 1986 and 1988. The redistributive effect, capturing the improvement in vertical inequality, and the revenue effect, capturing the loss in mean disposable income as a consequence of the tax, are combined to produce a measure of social welfare change. Then, following Lambert and Ramos (1996) the redistributive effect is decomposed into a horizontal and a vertical contribution. The main novelties we introduce are the following three. (a) We adopt an absolute framework which is seldom used in the empirical literature. (b) We emphasize the differences between the horizontal inequality due to the exemptions and tax credits not based on equity considerations, and what we call unintended horizontal inequality arising from: i) the practice of applying a progressive tax schedule to unadjusted incomes followed by family tax credits, rather than applying directly the tax schedule to income adjusted by family circunmstances; ii) differences between the analyst's equivalence scale and the implicit fiscal scale, and iii) the existence of other eharaeteristies, ignored by the analyst but taken as ethieally relevant by the fiscal authority. Among other things, this breakdown allows us a more detailed explanation than previous studies of the inerease in the horizontal inequality in Spain between 1986 and 1988. (c) Finally, we highlight a fundamental diffieulty in all methods, including ours, that rely on the partitíon by similars for the measurement of horizontal inequality.