Session 4 Fiscal Incidence Analysis in Pracce

Nora Lusg Tulane University Nonresident Fellow CGD and IAD

Learning Event on the Commitment to Equity Methodology Tulane University and the World Bank Washington, DC February 18 -20, 2015

This presentaon is based on:

Lusg, Nora and Sean Higgins (2013) Commitment to Equity Assessment (CEQ): Esmang the Incidence of Social Spending, Subsidies and Taxes. Handbook. CEQ Working Paper No. 1, Center for Inter-American Policy and Research and Department of Economics, Tulane University and Inter-American Dialogue, September.

If you use materials from this presentaon, please cite as shown.

2 CEQ Assessment: Objecves § What is the impact of taxes and transfers on inequality and poverty? § How equalizing are taxes and public spending? § How effecve is the fiscal system in reducing inequality and poverty? § Who bears the burden of taxes and receives the benefits? § How equitable is the use of educaon and health services? § Fiscal policy and rural/urban, gender and ethnic inequalies § Idenfy areas of potenal policy reform to enhance the capacity of the state to reduce inequality and poverty through taxes and transfers 3 CEQ Assessments and Fiscal Incidence Analysis

§ In order to answer the key quesons regarding fiscal policy and redistribuon, we need the income of individuals before and aer fiscal intervenons § Method: fiscal incidence analysis § Fiscal incidence analysis consists of methods to allocate taxes and public spending to individuals so that one can compare pre-fiscal incomes with incomes aer taxes and transfers

4 Basic elements of standard fiscal incidence

§ Before taxes and transfers income of unit h, or Ih

§ Taxes Ti § personal income taxes; contribuons to social security § consumpon and producon taxes and subsidies

§ Transfers Bi § social spending: cash & near-cash transfers; in-kind transfers (educaon and health) § consumpon and producon (agriculture) subsidies

§ “Allocators” of tax i and transfer j to unit h, or Sih , Sjh (the share of tax i borne or transfer j received by unit h) => Incidence

§ To generate the aer or post taxes and transfers income… 5 Fiscal Incidence Equaon

Income after Taxes Transfers taxes and transfers

Yh = Ih - ∑i TiSih + ∑j BjSjh

Income Share of tax Share of before i paid by transfer j taxes and unit h received by transfers unit h

6 Fiscal Intervenons

§ Taxes • Direct taxes: mainly PIT (miss top incomes except in tax-based analysis) • Contribuons to pensions and social insurance systems • Indirect taxes on consumpon: VAT, excise taxes, tariffs

7 Fiscal Intervenons

• Transfers • Direct cash transfers • Non-cash direct transfers such as school uniforms and breakfast • Indirect subsidies • In-kind transfers such as spending on educaon and health

8 Construcon of Income Concepts

MARKET INCOME

PLUS DIRECT TRANSFERS MINUS DIRECT TAXES

DISPOSABLE INCOME

MINUS NET INDIRECT TAXES

POST-FISCAL or CONSUMABLE INCOME

PLUS MONETIZED VALUE OF PUBLIC SERVICES: EDUCATION & HEALTH

FINAL INCOME 9 Fiscal Incidence in CEQ Assessments

§ Accounng approach • no behavioral • no general equilibrium effects and • no intertemporal effects • but it incorporates assumpons to obtain economic incidence (not statutory) § Point-in-me § Mainly average incidence; a few cases with marginal incidence

10 Fiscal Incidence in CEQ Assessments

§ Comprehensive standard fiscal incidence analysis of current systems: direct personal and indirect taxes (no corporate taxes); cash and in-kind transfers (public services); indirect subsidies § Harmonized definions and methodological approaches to facilitate cross-country comparisons § Uses income/consumpon per capita as the welfare indicator § Allocators vary => full transparency in the method used for each category, tax shiing assumpons, tax evasion § Secondary sources are used to a minimum

11 Allocaon Methods § Direct Idenficaon in microdata § However, results must be checked: how realisc are they?

§ If informaon not directly available in microdata, then: § Simulaon § Imputaon § Inference § Predicon § Alternate Survey § Secondary Sources

12 Tax Shiing Assumpons

• Economic burden of direct personal income taxes is borne by the recipient of income • Burden of payroll and social security taxes is assumed to fall enrely on workers • Consumpon taxes are assumed to be shied forward to consumers. • These assumpons are strong because they imply that labor supply is perfectly inelasc and that consumers have perfectly inelasc demand • In pracce, they provide a reasonable approximaon (with important excepons such as when examining effect of VAT reforms), and they are commonly used 13 Tax Evasion Assumpons: Case Specific

§ Income taxes and contribuons to SS: § Individuals who do not parcipate in the contributory social security system are assumed not to pay them

§ Consumpon taxes § Place of purchase: informal markets are assumed not to charge them § Some country teams assumed small towns in rural areas do not to pay them

14 Monezing in-kind transfers

§ Incidence of public spending on educaon and health followed so- called “benefit or expenditure incidence” or the “government cost” approach. § In essence, we use per beneficiary input costs obtained from administrave data as the measure of average benefits. § This approach amounts to asking the following queson: Ø How much would the income of a household have to be increased if it had to pay for the free or subsidized public service at the full cost to the government?

15 Indicators

§ Inequality and poverty: • Gini, Theil, Kuznetz raos, ineq of opportunity • Headcount, poverty gap, squared poverty gap (internaonal and naonal poverty lines) • Impoverishment and fiscal mobility • Inequality of Opportunity § Effecveness and Efficiency • Change in inequality or poverty divided by corresponding budget share or total spent • Poverty-reducon efficiency indicators • Tax producvity indicators

16 Indicators

§ Progressivity • Incidence by quanle or income group • Concentraon Shares • Concentraon Curves • Concentraon Coefficients, Kakwani, and Reynolds-Smolensky Index § Vercal Equity and Reranking Effects

17 Indicators

§ Measuring Contribuon to Redistribuon and Poverty- reducon • Classifying intervenons by whether they are equalizing or unequalizing • Classifying intervenons by whether they are equalizing or unequalizing • Ranking intervenons by their marginal contribuon to changes in inequality • Ranking intervenons by their marginal contribuon to changes in poverty

18 Indicators

§ Coverage of social programs by quanle and income group § Average per capita transfer received by the poor § Share of benefits going to the nonpoor § Average per capita transfer received by the nonpoor § Gross and net enrollment indicators by income group

19 Scenarios and Robustness Checks

§ Benchmark scenario § Sensivity to: • Changing the original income by which hh are ranked: e.g., market income plus contributory pensions and disposable income • Using consumpon vs. income • Per capita vs. equivalized income or consumpon • Different assumpons on scaling-down or up • Different assumpons on take-up of transfers and tax shiing and evasion • Alternave valuaons of in-kind services • Other sensivity scenarios: country-specific 20 Robustness Check Example from South Africa: Income vs. Consumpon-based Analysis

South Africa Gini estimates

Income based Consumption based scenario scenario Market income 0.771 0.723 Disposable income 0.704 0.634 Post-fiscal income 0.700 0.628 Final income 0.601 0.514

21 Fiscal Incidence Analysis Data Requirements § Ideally a naonwide Income-Expenditure household survey as recent as possible; however, methodological adaptaons exist for consumpon-only and income-only surveys (for the laer, CEQ uses matching techniques to a survey with consumpon data) § Fiscal budget data for same year as survey by spending and revenue lines § Macroeconomic and poverty data for context and checking § Detailed informaon on individual direct and indirect taxes, cash transfers, pension system/s, public educaon and healthcare systems, and indirect subsidies

22 Fiscal Incidence Analysis Recommended Team Structure

§ Econometrician/poverty analyst: works with HH survey and macro data to generate CEQ Assessment § Instuonal expert (in country): provides detailed informaon on tax and transfer system as well as macro and fiscal data § RA to support preparaon of MWB § Team size: from 2 (1 senior and 1 RA) to 10 (World Bank projects)

23 Fiscal Incidence Analysis Soware

§ Stata: ideally, Stata 13 (includes command to send results directly to MWB); previous Stata versions will need to do it manually

§ Compilaon of informaon: Excel for Master Workbook

24 Construcon of Income Concepts

MARKET INCOME

PLUS DIRECT TRANSFERS MINUS DIRECT TAXES

DISPOSABLE INCOME

MINUS NET INDIRECT TAXES

POST-FISCAL or CONSUMABLE INCOME

PLUS MONETIZED VALUE OF PUBLIC SERVICES: EDUCATION & HEALTH

FINAL INCOME 25 Market Income

+ Contributory pensions + Market Income plus Pensions + + - Direct transfers Direct taxes -

Gross Income Net Market Income - + Direct taxes Direct transfers

Disposable Income + + Indirect subsidies - Indirect taxes -

Disposable Income plus Disposable Income Indirect subsidies minus Indirect Taxes

+ Indirect taxes - Indirect subsidies

Consumable Income Market Income plus Pensions minus All Taxes + Educaon and + health services - Co-payments, - user fees

Market Income plus Pensions Final Income plus All Transfers Thank you!

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