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Estimating Equivalence Scales for Tax and Benefits Systems

  • John Muellbauer

    ()

    (Nuffield College, Oxford University, UK)

  • Justin van de Ven

    ()

    (National Institute of Economic and Social Research, UK)

When comparing, say, the welfare derived from income by a family that is comprised of two adults and three children to that of a single adult, it is necessary to take into consideration the relative needs of the respective households. The most common means by which applied studies in economics currently relate the needs of heterogeneous income units is through the use of equivalence scales. Despite a considerable research effort, however, almost every aspect of equivalence scale specification remains controversial. What characteristics should equivalence scales take into account? Should the scales apply an additive or multiplicative adjustment to income? Is the assumption of base independence valid?1 How should a reference unit be selected? Is it reasonable to assume that there is no inequality within an income unit? What criteria are most sensible for selecting a functional form? And, arguably most important, do the cardinal relations implied by equivalence scales permit income units to be compared in terms of underlying welfare? All of these questions remain largely unresolved. This paper is concerned with estimating the relativities that are implicit in tax and benefits policy. Using observed tax and benefits payments to estimate equivalence scales may mitigate some of the criticisms to which alternative scale specification criteria have been subject. For example, most econometric estimates of equivalence scales used for distributional analysis are based on consumer demand behaviour. Pollak and Wales (1979, p. 216) have notably criticised this methodology on the basis that “the equivalence scales required for welfare comparisons are logically distinct from those which arise in demand analysis”. The central difficulty is that demand analysis fails to provide a basis for making cardinal comparisons of welfare between households, and so equivalence scales that are estimated from expenditure data necessarily depend upon exogenously imposed value judgements. In contrast, part of the intuitive appeal of equivalence scales based on a country’s transfer system is the perception that such relativities embody a social consensus; that the tax and benefits system, being an observable instrument of government, can be used to infer the value judgements made by government when acting in its role as administrative agent for society. Comparison of the relativities that underlie taxation with equivalence scales based on the costs borne by heterogeneous income units could also provide a useful means for evaluating the adequacy of associated provisions made by transfer systems. Alternatively, the equivalence scales implicit in transfer systems could be used to compare the provisions made through time and/or between countries. Such equivalence scales could also play a role in the tax design process itself. In view of the fact that the redistributive systems of many countries are comprised of numerous different tax and benefit schemes, it is difficult to ensure that the overall system does in fact achieve the desired redistribution. Information about implicit scales — which may on reflection be found to differ from the values held by policy makers — can be useful in suggesting that certain features of the tax system need adjusting.

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File URL: http://www.nuff.ox.ac.uk/economics/papers/2004/W6/EstimatingEquivalence.pdf
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Paper provided by Economics Group, Nuffield College, University of Oxford in its series Economics Papers with number 2004-W06.

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Length: 33 pages
Date of creation: 25 Feb 2004
Date of revision:
Handle: RePEc:nuf:econwp:046
Contact details of provider: Web page: http://www.nuff.ox.ac.uk/economics/

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  1. Udo Ebert & Peter J Lambert, . "Horizontal Equity and Progession when Equivalence Scales are not Constant," Discussion Papers 02/02, Department of Economics, University of York.
  2. Seneca, Joseph J & Taussig, Michael K, 1971. "Family Equivalence Scales and Personal Income Tax Exemptions for Children," The Review of Economics and Statistics, MIT Press, vol. 53(3), pages 253-62, August.
  3. James Banks & Mike Brewer, 2002. "Understanding the relative generosity of government financial support for families with children," IFS Working Papers W02/02, Institute for Fiscal Studies.
  4. Balcer, Yves & Sadka, Efraim, 1986. "Equivalence scales, horizontal equity and optimal taxation under utilitarianism," Journal of Public Economics, Elsevier, vol. 29(1), pages 79-97, February.
  5. Kaplow, Louis, 1996. " Optimal Distribution and the Family," Scandinavian Journal of Economics, Wiley Blackwell, vol. 98(1), pages 75-92, March.
  6. Pollak, Robert A & Wales, Terence J, 1979. "Welfare Comparisons and Equivalence Scales," American Economic Review, American Economic Association, vol. 69(2), pages 216-21, May.
  7. Diamond, Peter A, 1998. "Optimal Income Taxation: An Example with a U-Shaped Pattern of Optimal Marginal Tax Rates," American Economic Review, American Economic Association, vol. 88(1), pages 83-95, March.
  8. Lewbel, Arthur, 1989. "Household equivalence scales and welfare comparisons," Journal of Public Economics, Elsevier, vol. 39(3), pages 377-391, August.
  9. Ebert, Udo & Lambert, Peter J, 1999. "Combined Income Taxes and Tax-Benefit Systems," The Economic Record, The Economic Society of Australia, vol. 75(231), pages 397-404, December.
  10. Mike Brewer & Tom Clark, 2002. "The impact on incentives of five years of social security reform in the UK," IFS Working Papers W02/14, Institute for Fiscal Studies.
  11. Robert J. Barro & Gary S. Becker, . "Fertility Choice in a Model of Economic Growth," University of Chicago - Population Research Center 88-8, Chicago - Population Research Center.
  12. Lambert, Peter J, 1993. "Inequality Reduction through the Income Tax," Economica, London School of Economics and Political Science, vol. 60(239), pages 357-65, August.
  13. Muellbauer, John, 1975. "The cost of living and taste and quality change," Journal of Economic Theory, Elsevier, vol. 10(3), pages 269-283, June.
  14. Lambert, Peter J. & Yitzhaki, Shlomo, 1997. "Income tax credits and exemptions," European Journal of Political Economy, Elsevier, vol. 13(2), pages 343-351, May.
  15. repec:cup:cbooks:9780521296762 is not listed on IDEAS
  16. Deaton, Angus S & Muellbauer, John, 1986. "On Measuring Child Costs: With Applications to Poor Countries," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 720-44, August.
  17. Donaldson, D. & Pendakur, K., 1999. "Equivalent-Income Functions and Income-Dependent Equivalence Scales," Discussion Papers dp99-8, Department of Economics, Simon Fraser University.
  18. Musgrave, Richard A., 1990. "Horizontal Equity, Once More," National Tax Journal, National Tax Association, vol. 43(2), pages 113-22, June.
  19. Bourguignon, F. & Spadaro, A., 2000. "Social Preferences Revealed through Effective Marginal Tax Rates," DELTA Working Papers 2000-29, DELTA (Ecole normale supérieure).
  20. Ebert, Udo, 1997. "Social Welfare When Needs Differ: An Axiomatic Approach," Economica, London School of Economics and Political Science, vol. 64(254), pages 233-44, May.
  21. Atkinson, A. B. & Bouguignon, F. & Chiappori, P. A., 1988. "What do we learn about tax reform from international comparisons? France and Britain," European Economic Review, Elsevier, vol. 32(2-3), pages 343-352, March.
  22. Moyes, Patrick & Shorrocks, Anthony, 1998. "The impossibility of a progressive tax structure," Journal of Public Economics, Elsevier, vol. 69(1), pages 49-65, July.
  23. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, vol. 38(114), pages 175-208, April.
  24. Creedy, J. & Van de Ven, J., 1998. "The Redistributive Effect of Selected Australian Taxes and Transfers on Annual and Lifetime Inequality," Department of Economics - Working Papers Series 658, The University of Melbourne.
  25. Rosen, Harvey S, 1978. "An Approach to the Study of Income, Utility, and Horizontal Equity," The Quarterly Journal of Economics, MIT Press, vol. 92(2), pages 307-22, May.
  26. Coulter, Fiona A E & Cowell, Frank A & Jenkins, Stephen P, 1992. "Differences in Needs and Assessment of Income Distributions," Bulletin of Economic Research, Wiley Blackwell, vol. 44(2), pages 77-124, April.
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