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Benefit incidence with incentive effects, measurement errors and latent heterogeneity

  • Ravallion, Martin
  • Chen, Shaohua

Empirical studies of tax and benefit incidence routinely ignore behavioral responses and measurement errors. This paper offers an econometric method of estimating the mean benefit withdrawal rate (marginal tax rate) allowing for incentive effects, measurement errors, and correlated latent heterogeneity in incidence. Under the method's identifying assumptions, a feasible instrumental variables estimator corrects for incentive effects and measurement errors, and provides a bound for the true value when there is correlated incidence heterogeneity. A case study for a large cash transfer program in China indicates that past methods of assessing benefit incidence using either nominal official rates or raw tabulations from survey data are deceptive. The program entails a nominal 100 percent benefit withdrawal rate -- a poverty trap. However, the paper finds that the actual rate is much lower, and clearly too low in the light of the literature on optimal income taxation. The paper discusses likely reasons based on the qualitative observations.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 6573.

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Date of creation: 01 Aug 2013
Date of revision:
Handle: RePEc:wbk:wbrwps:6573
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  1. Qin Gao & Irwin Garfinkel & Fuhua Zhai, 2009. "Anti-Poverty Effectiveness Of The Minimum Living Standard Assistance Policy In Urban China," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 55(s1), pages 630-655, 07.
  2. James J. Heckman & Sergio Urzua & Edward Vytlacil, 2006. "Understanding Instrumental Variables in Models with Essential Heterogeneity," The Review of Economics and Statistics, MIT Press, vol. 88(3), pages 389-432, August.
  3. Milligan, Kevin & Lemieux, Thomas, 2006. "Incentive Effects of Social Assistance: A Regression Discontinuity Approach," Analytical Studies Branch Research Paper Series 2006280e, Statistics Canada, Analytical Studies Branch.
  4. Meade, James E, 1972. "Poverty in the Welfare State," Oxford Economic Papers, Oxford University Press, vol. 24(3), pages 289-326, November.
  5. Appleton, Simon & Knight, John & Song, Lina & Xia, Qingjie, 2002. "Labor retrenchment in China: Determinants and consequences," China Economic Review, Elsevier, vol. 13(2-3), pages 252-275.
  6. Elliott Fan, 2010. "Who Benefits from Public Old Age Pensions? Evidence from a Targeted Program," Economic Development and Cultural Change, University of Chicago Press, vol. 58(2), pages 297-322, 01.
  7. Kevin Milligan, 2005. "Subsidizing the Stork: New Evidence on Tax Incentives and Fertility," The Review of Economics and Statistics, MIT Press, vol. 87(3), pages 539-555, August.
  8. Skoufias, Emmanuel & di Maro, Vincenzo, 2006. "Conditional cash transfers, adult work incentives, and poverty," Policy Research Working Paper Series 3973, The World Bank.
  9. Yonatan Ben-Shalom & Robert A. Moffitt & John Karl Scholz, 2011. "An Assessment of the Effectiveness of Anti-Poverty Programs in the United States," NBER Working Papers 17042, National Bureau of Economic Research, Inc.
  10. Emmanuel Saez, 2002. "Optimal Income Transfer Programs: Intensive Versus Extensive Labor Supply Responses," The Quarterly Journal of Economics, MIT Press, vol. 117(3), pages 1039-1073, August.
  11. Moffitt, Robert, 1992. "Incentive Effects of the U.S. Welfare System: A Review," Journal of Economic Literature, American Economic Association, vol. 30(1), pages 1-61, March.
  12. Francois Bourguignon & Luiz A. Pereira da Silva, 2003. "The Impact of Economic Policies on Poverty and Income Distribution : Evaluation Techniques and Tools," World Bank Publications, The World Bank, number 15090, September.
  13. Ravi Kanbur & Matti Tuomala, 2011. "Charitable conservatism, poverty radicalism and inequality aversion," Journal of Economic Inequality, Springer, vol. 9(3), pages 417-431, September.
  14. 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.
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