Distributional impact of alternative financing of social security André Decoster Centrum voor...

Distributional impact of alternative financing of social

securityAndré Decoster

Centrum voor Economische StudiënKULeuven

m.m.v.

Bart Capéau, Kris De Swerdt, Kristian Orsini

Gerre Verbist

Centrum voor Sociaal Beleid Herman DeleeckUniversiteit Antwerpen

Seminarie FOD Sociale Zekerheid – 13 februari 2006

13 februari 2006 Verdelingseffecten alternatieve financiering sociale zekerheid Prof. A. Decoster 2

Structure of the exposition

1. Some insights from tax theory

2. Empirical assessment:

1. incidence analysis of indirect taxes (ASTER)

2. incidence analysis of social security contributions

(MISIM)

3. effect of one scenario of shifting financing social

security from employee contributions to indirect

taxes

3. Summary and plans for further research


Focus of the analysis

only one alternative source: indirect tax more specifically VAT but policy relevant (Germany)


Insights from a theoretical perspective

tax on labour income

is a “distortion”

causing “problems”

remove this tax

tax on income from capital (on savings)

is unjust “distorts” labour/capital choice

remove this tax



there is a revenue constraint: separate discussion about size of government, amount of public goods

about “distortion”: in absence of lump sum instrument (“first best”), there is indeed a welfare cost associated with taxation (“second best”)

e.g. labour income tax changes relative price consumption/leisure and induces changes in this choice, can be expressed as efficiency loss of collecting revenue

But insight modern public finance: in second best world, removing one single distortion does not necessarily improve the situation (or: you do not minimize

welfare loss by minimizing number of distortions)



therefore question becomes: is shift from labour income tax to indirect tax welfare improving:

from efficiency point of view (less excess burden) from distributional point of view

what is the difference between labour income tax and indirect tax?

if proportional, and no other income: NONE! based on fundamental identity:

income = spending



1 1 2 2p C p C wL

1 1 2 2 (1 )p C p C w L

1 1 21 22(1 ) (1 )tp C p t C wL

tax on labour income

tax on consumption

1 2t t t

1 1 2 2

1

1 tp C p C wL

1

t



Example:

0.10t 0.111

t

t

0.14941

t

0.13



equivalence implies: one does not remove the distortion from the income tax by

switching from labour income tax to a uniform commodity tax using proportional commodity taxes amounts to removing the

progressivity of the (labour) income tax

Optimal Tax-theory: distortion (of labour income tax) might be decreased by

differentiating the indirect tax structure; taxing complements with leisure at a higher rate

might be more efficient to redistribute by means of differentiated indirect tax than by means of progressive income tax

Conclusion: simplistic argument “remove distortion” does not hold



what about taxation of savings?

income = spending + saving

intertemporal model is needed: uniformity result: not taxing saving (expenditure

tax) why depart from uniformity? efficiency arguments (new distortion: relative price

between consumption now and consumption later is changed)

distributional considerations: weight attached to different generations


Insights from a theoretical perspective: conclusion

theoretical arguments point in different directions

it is the joint effect of all distortions that matters, unilaterally removing just one (or a few) does not necessarily lead to welfare improvement

Pareto-improvements (which are at the core of the theoretical analysis) depend on the initial situation. This is not necessarily the real world situation

Distributional concerns matter

Hence: empirical assessment through simulation experiment is valuable


Structure of the exposition

1. Some insights from tax theory

2. Empirical assessment:

1. incidence analysis of indirect taxes (ASTER)

2. incidence analysis of social security contributions

(MISIM)

3. effect of one scenario of shifting financing social

security from employee contributions to indirect

taxes

3. Summary and plans for further research


Empricial assessment: MISIM and ASTER combined

MISIM ASTER

SEPNet incomes

Gross incomes

Labour cost

Budget survey

Employee contribution

s

Employer contributions

detailed consumption & taxes

Indirect taxes

detailed consumption & taxes

Indirect taxes

PIT


Incidence of indirect taxes

indirect tax structure differentiates between commodities

which interacts with the differentiated consumption patterns of households

we use the budget survey of 2001 to show these expenditure patterns and hence the variation in indirect tax

burden


% of total expenditures subjected to different VAT-rates (NIS Budget Survey 2001)

35.9

21.00.3

42.7

0%6%12%21%


Structure of total expenditures (average income shares)

21.713.4

12.612.1

9.86.5

4.44.1

3.12.5

1.91.51.41.21.110.90.8

0

0 5 10 15 20 25

RentLeisure commodities

FoodOther (n.e.c.)

DurablesHygienics, health exp.

ClothingElectricity, gas

Private transport (non durable)Housing maintenance

GasolineDrinks: alcoholic

Domestic Fuel OilSaving

TobaccoDrinks: non alcoholic

DieselPublic Transport

LPG

% of disposable income


Structure of expenditures

conceals considerable heterogeneity across households

e.g.: variation in function of disposable income

share of food


income share of food expenditures (NIS budget survey 2001)

0.2

.4.6

.8in

kom

ensa

ande

el v

oedi

ng

0 20000 40000 60000 80000 100000 120000beschikbaar inkomen - € 2001


0.1

.2.3

.4in

kom

ensa

ande

el v

oedi

ng

0 10000 20000 30000 40000 50000 60000 70000 80000 90000 100000beschikbaar inkomen - € 2001

might be explained by: income household size age of hh members many other characteristics preferences in general

income share of food expenditures (NIS budget survey 2001)


Stylized representation of food share

23.1

16.114.6

13.712.7

11.710.4 9.8

8.9

6.5

0

5

10

15

20

25

1 2 3 4 5 6 7 8 9 10

decile of equivalized disposable income

Food share


Non parametric estimations of income shares (Kernel)

Hence, to impute an expenditure structure in a dataset without expenditures (e.g. CSB), we need to estimate this relationship

is done by means of econometric estimation in which following explanatory variables help to explain the income shares:

disposable income household composition (size, age) region

there remains unexplained variation


0.00

0.01

0.01

0.02

0.02

0.03

0.03

1 3 9 20 34 52 68 83 93 97

percentile of equivalized disposable income

income share

Kernel

polynome

Estimation of income share “domestic fuel oil”


-1.50

-1.00

-0.50

0.00

0.50

1.00

1 3 9 20 34 52 68 83 93 97


income share

Kernel

polynome

estimation of income share “saving”


-0.30

-0.20

-0.10

0.00

0.10

0.20

0.30

0.40

0.50

1 3 9 20 34 52 68 83 93 97


income share

Rent

Food

Saving

Some Kernel-Engelcurves (income shares)


0.00

0.02

0.04

0.06

0.08

0.10

0.12

0.14

0.16

1 3 9 20 34 52 68 83 93 97


income share

Durables

Leisure commodities

Hygienics and health

Some Engelcurves


0.00

0.01

0.02

0.03

0.04

0.05

0.06

1 3 9 20 34 52 68 83 93 97


income share

Private transport

Public transport

Some Engelcurves


Result 1: % of expenditures in VAT-classes (by decile)

36.2 35.7 35.8 35.0 35.7 35.436.9 36.4

34.837.6

26.224.8

23.3 23.021.3 20.9 19.8

18.3 18.0

14.7

37.039.0

40.4 41.6 42.7 43.5 43.145.1

46.9 47.6

10

15

20

25

30

35

40

45

50

1 2 3 4 5 6 7 8 9 10

decile of equivalized disposable income

share in total expenditures 0% 6% 21%


Result 2: Incidence of VAT by decile

9.6 9.6 9.7

9.18.8 8.9

8.2

8.7

8.1

6.87.5

8.17.8

8.3

8.9 8.7 8.8

8.2

11.0

10.2

6

7

8

9

10

11

12

1 2 3 4 5 6 7 8 9 10

decile of equivalized disposable income or expenditures

share in income

income deciles

expenditure deciles


Incidence of Excise by decile

1.4

1.61.7

1.6 1.6 1.6

1.41.3

1.2

0.91.0

1.41.5

1.6

1.4

1.61.5

1.41.5

1.3

0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

1 2 3 4 5 6 7 8 9 10


share in income

income deciles

expenditure deciles


Incidence of indirect tax (VAT+excise) by decile

11.1 11.2 11.4

10.710.3 10.4

9.610.1

9.3

7.78.5

9.4 9.39.9

10.4 10.3 10.3

9.6

12.5

11.4

6

7

8

9

10

11

12

13

14

1 2 3 4 5 6 7 8 9 10


share in income

income deciles

expenditure deciles


MISIM

= MIcroSImulationModel of social security and personal income tax

developed by the Centre for Social Policy On the basis of data of Socio-Economic

Panel (SEP) 1997, indexed up to 2005 Policy rules of August 2005 for calculation

of social security contributions of employer social security contributions of employee personal income tax


Calculation contributions employer

1. contribution employer for private and public sector

• private sector: difference between blue and white collar, and number of employees is taken into account

2. reduction of contribution employer• structural reduction (in MISIM)• specific reductions (only partially in MISIM)• other reductions (not in MISIM)


Calculation contributions employee

1. Own contributions for public and private sector

• 13.07% in private sector and public sector without tenure contract (blue/white collar)

• 11.05% civil servants• reduction for low labour incomes (“werkbonus”)

2. own contributions for self-employed3. contributions on replacement incomes

(pensions, sickness and invalidity)


Distribution by decile of welfare (MISIM 2005)(private and public sector, self-employed)

0

1000

2000

3000

4000

5000

6000

7000

8000

1 2 3 4 5 6 7 8 9 10

Labour income employers contribution own contribution


Employees: % contribution on gross wage by decile

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

1 2 3 4 5 6 7 8 9 10

Employer Employee


Self-employed: % contribution on gross labour income by decile

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

1 2 3 4 5 6 7 8 9 10

Eigen bijdragen zelfstandigen


Replacement incomes: % contribution on gross pension by decile

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

1 2 3 4 5 6 7 8 9 10

Eigen bijdragen pensioenen


Scenario for alternative financing of Social Security

Gross wage

1. Contribution: 13.07% (private) / 11.05% (public)

2. Reduction: -15%3. application of workbonus

Taxable incomePersonal income taxNet disposable income

Note: own contributions self-employed and replacement incomes do not change!


Scenario for alternative financing of Social Security

Only effect (and direct): disposable income, not on labour cost (and hence labour demand)

labour demand perfectly elastic (horizontal) No effect on labour supply (preliminary)

labour supply: perfectly inelastic (vertical) Revenue neutrality by increase of

indirect taxes (VAT, not excises) Behavioural reactions through budget

shares that respond on change in disposable income


Revenue neutrality

Million €

reduction of contributions employees -1675

increase in income taxes 876

net cost -798

Increase VAT to collect additional revenu of 0,8 bn €? No, since ASTER only captures VAT-receipts from

consumption by private households Ratio ASTER VAT/Total VAT=67% Hence: increase VAT to get 0.67x798 = 535 million €


Revenue neutrality

scenarios to collect the 535 million €:

Mio €

increase all VAT-rates by 5% (6,3 and 22,1) 468

increase all VAT-rates by 6% (6,7 and 23,4) (A)

550

increase the 21%-rate to 22% 364

increase the 21%-rate to 23% (B) 669


Change in consumer price for scenario A and B

0.0

0.5

1.0

1.5

2.0

2.5

% change in consumer price

6.3 & 22.1 21 to 23


Change in consumer price for scenario A and B

0.0

5.0

10.0

15.0

20.0

25.0

30.0

Tobacco Gasoline Diesel oil LPG

% change in consumer price

6.3 & 22.121 to 23


Evaluation for each household

income change: disposable income of those who earn labour income as employee increases

price change: to buy the same bundle of commodities, one needs more income

average effect for the two scenario’s (€ of 2005):

A: 6.3 & 22.1 B: 21 to 23

income change 197 (0,74%) 197 (0,74%)

price change (loss)

145 (0,54%) 196 (0,74%)

total welfare effect

52 (0,19%) 0


Income and price change by decile: Scenario A

-100

-50

0

50

100

150

200

250

300

350

400

450

1 2 3 4 5 6 7 8 9 10

money metric (€ 2005)

income

price (loss)

total


Income and price change by decile: Scenario B

-100

0

100

200

300

400

500

1 2 3 4 5 6 7 8 9 10


income

price (loss)

total


welfare change by decile: Scenario B

-80

-60

-40

-20

0

20

40

60

80

1 2 3 4 5 6 7 8 9 10


-0.8

-0.7

-0.6

-0.5

-0.4

-0.3

-0.2

-0.1

0

0.1

0.2

0.3


absolute loss

in % of disposable income


Income and price change by socio-professional group: Scenario B

-300

-200

-100

0

100

200

300

400

500

inactive civil servant employee self-employed


income price (loss) total


welfare change by socio-professional category: Scenario B

-250

-200

-150

-100

-50

0

50

100

150

200

inactive civilservant

employee

self-employed


-0.6

-0.4

-0.2

0

0.2

0.4

0.6


absolute loss

in % of disposable income


Caveat’s

Labour supply reaction not taken into account

but research in other context: might be small preliminary research on PSBH-dataset by means

of discrete choice model of labour supply (only for couples):

Baseline (1000) change (units)

%

employment men 1,603 4385 0.27

employment women

1,255 3461 0.28

hours men 69,176 273031 0.39

hours women 38,798 150206 0.39


Caveat’s

Labour supply reaction increase in disposable income might be too

small also labour supply reaction is different

across deciles: more than 40% of the increase in employment occurs in the bottom decile

welfare gain of increased employment: not only income (or consumption) changes, but also

change in leisure time welfare effect of “social inclusion”


Caveat’s

Labour supply reaction not taken into account

Labour demand effects might be more important

currently: (research) trade-off between using a model with detailed distributional effects and one which models both sides of labour market (or more generally: traditional macro, CGE)

frontier of research on micro-macro links


Conclusion

revenue neutrality cannot be discarded in the debate

“nonsens remains nonsens”: (some) equivalence between labour income taxation and commodity taxes

hence, importance of distributional assessment

intuition about important distributional consequences is confirmed

important intergenerational aspects

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