Tax-benefits indicators from a
work incentives perspective
Comments upon
Christopher Heady and Herwig Immervoll –
“Rewarding Jobs: Government Policy and Work Incentives”
By Paolo Sestito
Economic Adviser
Ministry of Labour and Social Policy - Italy
Comments Outline
• Taxes and benefits from a labour supply perspective
• Notional effective rates as a summary measure of the
impact of taxes and benefits upon the relevant budget
constraint faced by potential workers
• When those synthetic measures make sense
– Summary of potentialities and pitfalls of those summary
measures
• An agenda for further developments
– Which indicators and how to choose among indicators
– How to complement notional effective rates
Taxes and benefits from a
labour supply perspective
• Taxes and benefits reshape the whole feasibility frontier
(the budget constraint) in the income/leisure space
– Different slopes over different segments
– Kinks and non convexities
• For each individual one would need to consider the
whole budget constraint
• Personal and family characteristics shape the budget
constraint as they impact upon both taxes and benefits.
Relevant cases also depend upon individuals’ gross
wage (his or her marginal product) and “tastes” (taste
shifters being related to personal and family
characteristics)
Notional effective rates
as a summary measure
• Average effective rates as a convexification of the
budget constraint with respect to a given discrete
choice (work a given amount of time/effort vs. nonwork)
• Marginal effective rates as measure of the local slope
(piecewise linearization of the budget constraint)
• The relevance of both is conditional upon the
relevance of personal and family circumstances
(including productivity and the gross wage one can
earn in the market) and of the discrete choice/local
segment under consideration.
When those summary measures
make sense
• The personal/family related circumstances have to identify
empirically relevant (high supply elasticity) groups and
situations:
– productivity (APW levels)
– Family types and individuals within families
• The discrete choices and the local segments have to be
empirically relevant (for the groups and situations under
examination).
– Notice that such an empirical relevance may depend upon the shape of
the whole budget constraint (technically speaking being endogenously
determined)
• Dynamic considerations – including entitlement effects
possibly associated to benefit schemes - have to be neglected
as less relevant.
How far summarizing?
• Average rates are already a summary measure of the whole budget
constraint (whose validity depends however upon the
identification of the relevant discrete binary comparisons, which
depend upon the whole individual’s budget constraint and
preferences)
• Marginal rates are not a summary measure. One further step might
then be “averaging” them over given (empirically relevant)
segments of the budget constraint
– However, in doing so one would need to preserve their nature of marginal
rates (eg. consider the mode/median and the range of the marginal rates
over the selected segment)
• Summary across different cases?
– Maybe, but rather cautiously and only in order to summarize countries and
time periods comparisons
– In any case, averaging a relatively large number of cases seems more
sensible than arbitrarily picking up one given case (as unfortunately often
made in the EU context!)
Potentialities and pitfalls
• Easy and fast updates of the notional rates (possibly
even with respect to planned changes whose
implications may so be easily grasped)
• Possible use in a benchmarking context because of the
rather immediate meaning and comprehensive nature
of the notional rates
• However, benchmarking has to be made cautiously
because of their summary nature (particularly when
aggregating over different cases)
• Moreover, notional rates do not provide an assessment
of resources implications and redistributional impact of
policy packages, issues inescapable when shaping tax
and benefits systems
Further developments - 1
• Relevant situations/groups – common priority areas
– Benefits recipients: need to take into account the (empirical) plurality of schemes
and the differences usually existing over their potential duration (as a first
approximation of more dynamic considerations)
– Secondary earners (in the household): start from a focus upon the marginal net
income implications for the household treated as an integrated decision-maker,
later on taking into account of more complex decision-making structures; need to
to take into account the care costs implications of the work decision?
– Elderly workers: the static framework implied by the approach is not really
capable to deal with these issues; on the other hand, the other approaches often
implemented unrealistically assume perfect foresight and perfect capital markets
– Low wage/low effort (hours) workers as high elasticity suppliers
• Gross labour cost vs. earnings (net of employers’
contributions)
– Marginal product linked to gross labour cost
– Is self-employment so easily available to justify netting from employers
contributions?
– Role of perceptions and the perceived role of total (employers’+employees’) social
security contributions
Further developments - 2
• Exploit the fast update features of the approach
– Notional rates may be produced with respect to the
rules normally dictated for the forthcoming year
• Balance national and international perspectives
– The relevant cases to be selected may differ across countries and
over time, their salience possibly being affected by the tax and
benefits system itself.
– Tradeoff between the use of common and constant cases capable to
benchmark countries and their evolution over time and the
relevance of the selected indicators in each given country/time
period.
Further developments - 3
• Need to complement notional rates with other
approaches
– Macro measures do not seem very sensible in order to provide
indicators
– Microsimulation models on the contrary may provide a better
assessment of concrete policy packages (which may also be
simulated assuming a balanced budget in order to focus upon
redistribution/work incentives tradeoffs) and may better identify
nationally relevant cases.
– Microsimulation models may also simulate implications of
expected socio-demographic changes. On their basis one might
update weighted averages of notional rates in the far future