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Distributional impact of alternative financing of social security. André Decoster Centrum voor Economische Studiën KULeuven m.m.v. Bart Capéau, Kris De Swerdt, Kristian Orsini Gerre Verbist Centrum voor Sociaal Beleid Herman Deleeck Universiteit Antwerpen

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distributional impact of alternative financing of social security

Distributional impact of alternative financing of social security

André Decoster

Centrum voor Economische StudiënKULeuvenm.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

structure of the exposition
Structure of the exposition
  • Some insights from tax theory
  • Empirical assessment:
    • incidence analysis of indirect taxes (ASTER)
    • incidence analysis of social security contributions (MISIM)
    • effect of one scenario of shifting financing social security from employee contributions to indirect taxes
  • Summary and plans for further research

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

focus of the analysis
Focus of the analysis
  • only one alternative source: indirect tax
  • more specifically VAT
  • but policy relevant (Germany)

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

insights from a theoretical perspective
Insights from a theoretical perspective

tax on income from capital (on savings)

tax on labour income

  • is unjust
  • “distorts” labour/capital choice

is a “distortion”

causing “problems”

remove this tax

remove this tax

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

insights from a theoretical perspective1
Insights from a theoretical perspective
  • 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)

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

insights from a theoretical perspective2
Insights from a theoretical perspective
  • 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

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

insights from a theoretical perspective3
Insights from a theoretical perspective

tax on labour income

tax on consumption

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

insights from a theoretical perspective4
Insights from a theoretical perspective
  • Example:

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

insights from a theoretical perspective5
Insights from a theoretical perspective
  • 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

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

insights from a theoretical perspective6
Insights from a theoretical perspective
  • 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

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

insights from a theoretical perspective conclusion
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

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

structure of the exposition1
Structure of the exposition
  • Some insights from tax theory
  • Empirical assessment:
    • incidence analysis of indirect taxes (ASTER)
    • incidence analysis of social security contributions (MISIM)
    • effect of one scenario of shifting financing social security from employee contributions to indirect taxes
  • Summary and plans for further research

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

empricial assessment misim and aster combined
Empricial assessment: MISIM and ASTER combined

Labour cost

Employer contributions

Gross incomes

PIT

Employee contributions

Net incomes

SEP

Budget survey

Indirect taxes

Indirect taxes

detailed consumption & taxes

detailed consumption & taxes

MISIM

ASTER

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

incidence of indirect taxes
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

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

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

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

structure of total expenditures average income shares
Structure of total expenditures (average income shares)

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

structure of expenditures
Structure of expenditures
  • conceals considerable heterogeneity across households
  • e.g.: variation in function of disposable income
    • share of food

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

income share of food expenditures nis budget survey 2001
income share of food expenditures (NIS budget survey 2001)

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

income share of food expenditures nis budget survey 20011
income share of food expenditures (NIS budget survey 2001)
  • might be explained by:
  • income
  • household size
  • age of hh members
  • many other characteristics
  • preferences in general

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

slide20

Stylized representation of food share

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

non parametric estimations of income shares kernel
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

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

slide22

Estimation of income share “domestic fuel oil”

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

slide23

estimation of income share “saving”

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

slide24

Some Kernel-Engelcurves (income shares)

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

slide25

Some Engelcurves

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

slide26

Some Engelcurves

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

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

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

result 2 incidence of vat by decile
Result 2: Incidence of VAT by decile

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

incidence of excise by decile
Incidence of Excise by decile

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

incidence of indirect tax vat excise by decile
Incidence of indirect tax (VAT+excise) by decile

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

misim
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

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

calculation contributions employer
Calculation contributions employer
  • contribution employer for private and public sector
    • private sector: difference between blue and white collar, and number of employees is taken into account
  • reduction of contribution employer
    • structural reduction (in MISIM)
    • specific reductions (only partially in MISIM)
    • other reductions (not in MISIM)

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

calculation contributions employee
Calculation contributions employee
  • 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”)
  • own contributions for self-employed
  • contributions on replacement incomes (pensions, sickness and invalidity)

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

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

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

employees contribution on gross wage by decile
Employees: % contribution on gross wage by decile

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

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

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

replacement incomes contribution on gross pension by decile
Replacement incomes: % contribution on gross pension by decile

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

scenario for alternative financing of social security
Scenario for alternative financing of Social Security

Gross wage

  • Contribution: 13.07% (private) / 11.05% (public)
  • Reduction: -15%
  • application of workbonus

Taxable income

Personal income tax

Net disposable income

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

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

scenario for alternative financing of social security1
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

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

revenue neutrality
Revenue neutrality
  • 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 €

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

revenue neutrality1
Revenue neutrality
  • scenarios to collect the 535 million €:

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

change in consumer price for scenario a and b
Change in consumer price for scenario A and B

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

change in consumer price for scenario a and b1
Change in consumer price for scenario A and B

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

evaluation for each household
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):

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

income and price change by decile scenario a
Income and price change by decile: Scenario A

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

income and price change by decile scenario b
Income and price change by decile: Scenario B

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

welfare change by decile scenario b
welfare change by decile: Scenario B

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

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

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

welfare change by socio professional category scenario b
welfare change by socio-professional category: Scenario B

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

caveat s
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):

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

caveat s1
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”

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

caveat s2
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

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

conclusion
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

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