The Lifetime INcome Distributional Analysis model: LINDA A model to generate lifetime incomes for a population cross-section Justin van de Ven (justin.van@unimelb.edu.au), Martin Weale & Paolo Lucchino July, 2014

Outline Purpose of the model A model design fit for purpose Selected model features Suitable issues for analysis Desirable extensions A practical example

Purpose of the model A model to simulate lifetime net incomes of a representative cross-section of the UK population, before and after a change to tax and/or benefit policy a model to produce analysis in terms of lifetime incomes not possible with pre-existing analytical tools

A model design fit for purpose A wide range of alternative analytical approaches exist, which can be organised according to two key dimensions: the dimensionality of the considered population the basis for projecting behavioural responses The selected modelling approach is tailored to the analytical purpose

A model design fit for purpose Principal model alternatives concerning the dimensionality of the considered population: case-study birth cohort population cross-section at a point in time evolving population cross-section

A model design fit for purpose Principal model alternatives concerning the dimensionality of the considered population: case-study birth cohort population cross-section at a point in time evolving population cross-section

A model design fit for purpose Principal model alternatives concerning the basis for projecting behavioural responses: exogenous “rule-of thumb” static reflection of past decisions non-structural reduced form relationships explicit behavioural assumptions, ignoring uncertainty structural relationships with analytical solutions explicit behavioural assumptions, accommodating uncertainty structural relationships without analytical solutions

A model design fit for purpose Principal model alternatives concerning the basis for projecting behavioural responses: exogenous “rule-of thumb” static reflection of past decisions non-structural reduced form relationships explicit behavioural assumptions, ignoring uncertainty structural relationships with analytical solutions explicit behavioural assumptions, accommodating uncertainty structural relationships without analytical solutions

Selected model features Reference population cross-section: all individuals aged 18+ reported in the WAS between July 2006 and June 2007 weights adjusted to reflect the UK Unit of analysis: benefit units, defined as a single adult or adult couple, and their dependent children (to age 17) Period of analysis: model projects at annual intervals forward and backward through time, building up a complete life history for each adult (from age 18)

Selected model features Behavioural assumptions: life-cycle model of behaviour allow for uncertainty implies no analytical solution to the decision problem model is consequently based on (numerical) dynamic programming methods

Selected model features Characteristics that distinguish benefit units year of birth - age relationship status - number of children by age student status - education self-employed/employee - wage potential reference adult wage potential of spouse - savings held in ISAs eligible private pension - private pension wealth timing of pension access - state pension based on BSP state pension on S2P - wealth not otherwise defined time of death

Selected model features Decisions (utility maximising) consumption - employment of each adult private pension participn - timing of access to pension investments in ISAs - investments in risky assets

Suitable issues for analysis Model is an appropriate tool for considering two types of research question: What are the plausible implications of a given policy environment for the distribution of lifetime income? e.g. How does lifetime income vary by individual characteristics such as birth year / education / relationship status / children / etc? What are plausible behavioural responses to a given change in the policy environment? e.g. How do responses to a given policy change vary by lifetime income decile?

Suitable issues for analysis Focussed on the healthy population Includes a broad range of taxes and benefits 2006 and 2010 transfer systems explicitly modelled and altered through an Excel front-end Taxes and benefits programming code can be accessed and altered as desired Individual transfer schemes are separately represented in code Allows for a reasonable degree of flexibility in relation to pensions

Desirable extensions We are a long way short of a “model of everything” Primary model extensions: allowing for the evolving population cross-section allowing the model to switch between structural decision making and reduced form decision making explicit allowance for owner-occupied housing wealth

A practical example Policy reform involving the introduction of a citizen’s pension set equal in value to the Pension Guarantee, off-set by a rise in the basic rate of tax Citizen’s pension replaces the Pension Credit Value of citizen’s pension: £114.05 pw for singles, £174.05 pw for couples Basic rate of tax increased from 22% to 34% Without tax increase, tax revenue net of benefits reduced by £34Bn in 2006

A practical example – behavioural effects

A practical example – behavioural effects

A practical example – welfare effects

A practical example – welfare effects

A practical example – income effects

A practical example – income effects