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Comparing Welfare Change Measures with Income Change Measures in Behavioural Policy Simulations

  • John Creedy

    (Department of Economics, The University of Melbourne)

  • Nicolas Hérault

    ()

    (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne)

  • Guyonne Kalb

    ()

    (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne)

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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Paper provided by Melbourne Institute of Applied Economic and Social Research, The University of Melbourne in its series Melbourne Institute Working Paper Series with number wp2007n21.

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Length: 31 pages
Date of creation: Aug 2007
Date of revision:
Handle: RePEc:iae:iaewps:wp2007n21
Contact details of provider: Postal: Melbourne Institute of Applied Economic and Social Research, The University of Melbourne, Victoria 3010 Australia
Phone: +61 3 8344 2100
Fax: +61 3 8344 2111
Web page: http://www.melbourneinstitute.com/
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  1. Apps, P.F. & Rees, R., 1998. "On the Taxation of Trade Within and Between Households," Papers 337, Australian National University - Department of Economics.
  2. 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.
  3. John Creedy, 2000. "Quadratic utility, labour supply and the welfare effects of tax changes," Australian Journal of Labour Economics (AJLE), Bankwest Curtin Economics Centre (BCEC), Curtin Business School, vol. 4(4), pages 270-278, December.
  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 & 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.
  6. Hausman, Jerry A., 1985. "Taxes and labor supply," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 1, chapter 4, pages 213-263 Elsevier.
  7. 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.
  8. Arthur van Soest, 1995. "Structural Models of Family Labor Supply: A Discrete Choice Approach," Journal of Human Resources, University of Wisconsin Press, vol. 30(1), pages 63-88.
  9. John Creedy & Guyonne Kalb, 2005. "Discrete Hours Labour Supply Modelling: Specification, Estimation and Simulation," Journal of Economic Surveys, Wiley Blackwell, vol. 19(5), pages 697-734, December.
  10. 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.
  11. Small, Kenneth A & Rosen, Harvey S, 1981. "Applied Welfare Economics with Discrete Choice Models," Econometrica, Econometric Society, vol. 49(1), pages 105-30, January.
  12. 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.
  13. M. Keane & R. Mofitt, 1995. "A Structural Model of Multiple Welfare Program Participation and Labor Supply," Working Papers 95-4, Brown University, Department of Economics.
  14. Hausman, Jerry A, 1981. "Exact Consumer's Surplus and Deadweight Loss," American Economic Review, American Economic Association, vol. 71(4), pages 662-76, September.
  15. 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.
  16. Latham, Roger W, 1980. "Quantity Constrained Demand Functions," Econometrica, Econometric Society, vol. 48(2), pages 307-13, March.
  17. John K. Dagsvik & Anders Karlstr�m, 2005. "Compensating Variation and Hicksian Choice Probabilities in Random Utility Models that are Nonlinear in Income," Review of Economic Studies, Oxford University Press, vol. 72(1), pages 57-76.
  18. repec:cup:cbooks:9780521348102 is not listed on IDEAS
  19. John Creedy & Alan S. Duncan & Mark Harris & Rosanna Scutella, 2002. "Microsimulation Modelling of Taxation and the Labour Market," Books, Edward Elgar, number 2796, December.
  20. Creedy, John & Duncan, Alan, 2002. " Behavioural Microsimulation with Labour Supply Responses," Journal of Economic Surveys, Wiley Blackwell, vol. 16(1), pages 1-39, February.
  21. Guyonne Kalb & Rosanna Scutella & Hsein Kew, 2002. "Estimation of Wage Equations in Australia: Allowing for Censored Observations of Labour Supply," Melbourne Institute Working Paper Series wp2002n26, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne.
  22. John Creedy & Guyonne Kalb, 2005. "Measuring Welfare Changes In Labour Supply Models," Manchester School, University of Manchester, vol. 73(6), pages 664-685, December.
  23. Duncan, Alan & Weeks, Melvyn, 1997. "Behavioural tax microsimulation with finite hours choices," European Economic Review, Elsevier, vol. 41(3-5), pages 619-626, April.
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