Manos Matsaganis & Panos Tsakloglou Athens University of Economics FBBVA Microsimulation Workshop Madrid November 2004 Microsimulation and the analysis of poverty and inequality an illustration

Microsimulation, poverty and inequality (1)  MS can help analyse the effect of policy changes  examine redistributive impact of current policies  explore impact of reforms vs. some baseline  answer counterfactual («what if»-type) questions

Microsimulation, poverty and inequality (2)  MS can help produce various types of output  analyse the impact of policy changes in terms of:  changes in the income distribution  poverty and inequality  distribution of gains and losses  i.e. winners and losers in the entire population... ... or by population group (lone parents, elderly etc.)  fiscal implications of policy changes  excl. administrative costs

Microsimulation, poverty and inequality (3)  MS can help calculate RRs and METRs  replacement rates  does work pay?  marginal effective tax rates  poverty trap?  unemployment trap?

Microsimulation, poverty and inequality (4)  MS can help disentangle separate effects  taxes and benefits interact  e.g. raising benefit rates will raise pre-tax incomes, so it may move recipients to a higher tax band... ... while lowering taxes will raise pre-tax incomes, so it may cause recipients of income-tested benefits to lose eligibility  no other way to account (separately and jointly) for the effect of taxes and benefits on final disposable incomes

An illustration Matsaganis M., O’Donoghue C., Levy H., Coromaldi M., Mercader-Prats M., Rodrigues C.F., Toso S., Tsakloglou P. «Child poverty and family transfers in southern Europe» Working Paper EM 2/04 Microsimulation Unit, University of Cambridge

 1. Introduction  2. Data and methodology  3. Incidence of child poverty by household type  4. Distributional impact of family transfers  5. Simulating reforms  6. Discussion and policy implications

The paper  aims to assess the impact –of family transfers –on child poverty –in southern Europe Greece Italy Spain Portugal  using microsimulation –the tax-benefit model EUROMOD

Family transfers  definition  all income transfers to families with children  child benefits (non-contributory)  family allowances (contributory)  tax relief for dependent children  non-cash benefits (e.g. child care) not included

Child poverty  issue has risen to prominence –poor children by definition “deserving” –social costs of child poverty vs. benefits of early intervention  anti-poverty measures  human capital investments  high future returns!  political commitments –Blair pledge to eliminate child poverty in Britain by 2020 –Commission proposal to halve child poverty in the EU by 2010 (not endorsed by the Council)

Southern Europe  tradition of “familialism”  strength of informal safety nets  but are family resources adequate for intra-family redistribution?  subsidiary role of formal safety nets  public assistance to families meagre / not available at all  reliance of tax benefits  what about those too poor to pay tax?  uneven coverage  gaps in protection

 1. Introduction  2. Data and methodology  3. Incidence of child poverty by household type  4. Distributional impact of family transfers  5. Simulating reforms  6. Discussion and policy implications

EUROMOD (1)  what is it? –a tax-benefit model for all 15 “old” EU members  construction funded by EC TSER / FP5 programmes  40 persons in 18 centres led by Cambridge University  main objective: comparability  what can it do? –analyse policy changes in a comparative setting  examine impact of current policies  explore impact of reforms  answer “what if?”-type questions

EUROMOD (2)  what data does it rely upon?  EC Household Panel (Greece / Spain / Portugal)  Bank of Italy Survey of Household Income & Wealth  updated to 1998  2001 dataset in progress  what sort of policies does it simulate?  income taxes, social contributions  social assistance, housing, family, unemployment and some social insurance benefits, e.g. social pensions  1998 & 2001 rules applied  2003 update in progress

EUROMOD (3)  what types of output does it produce? –estimates of policy impact in terms of:  income distribution  fiscal costs  distribution of gains and losses (winners and losers) –calculations of:  marginal effective tax rates  replacement rates

EUROMOD (4)  temporary difficulties? –no simulation of benefits in kind (publicly provided services) –full tax compliance (no tax evasion) –no targeting errors (100% take up / no leakage)  given sufficient effort (and funding), all of the above may be fully or partly amenable to treatment

EUROMOD (5)  structural weaknesses?  static microsimulation  no behavioural responses  e.g. labour supply  consumer demand etc.  nonetheless:  dynamic models sensitive to assumptions  in the short term, static MS may be sufficient

 1. Introduction  2. Data and methodology  3. Incidence of child poverty by household type  4. Distributional impact of family transfers  5. Simulating reforms  6. Discussion and policy implications

Table 2a Child poverty rates GreeceItalySpainPortugal couple with 1 child couple with 2 children couple with 3+ children lone parent: all children lone parent: 1+ child couple with 1+ child other hh types with children all households with children all households

Table 2b Contribution to aggregate child poverty GreeceItalySpainPortugal couple with 1 child couple with 2 children couple with 3+ children lone parent: all children lone parent: 1+ child couple with 1+ child other hh types with children all households with children100.0

 1. Introduction  2. Data and methodology  3. Incidence of child poverty by household type  4. Distributional impact of family transfers  5. Simulating reforms  6. Discussion and policy implications

Table 7a Estimated value of cash benefits family sizeincomeGreeceItalySpainPortugal 1 child low middle high children low middle high children low middle high children low middle high

Table 7b Estimated value of tax relief family sizeincomeGreeceItalySpainPortugal 1 child low middle high children low middle high children low middle high children low middle high

Graph 1 Concentration curves

Table 11a Impact on child poverty rates GreeceItalySpainPortugal couple with 1 child couple with 2 children couple with 3+ children lone parent: all children lone parent: 1+ child couple with 1+ child other hh types with children all households with children Percentage reduction in the number of poor children due to current policies

Table 11b Impact on child poverty gaps GreeceItalySpainPortugal couple with 1 child couple with 2 children couple with 3+ children lone parent: all children lone parent: 1+ child couple with 1+ child other hh types with children all households with children Percentage reduction in the aggregate child income gap due to current policies

Table 12 Redistributive impact of family transfers GreeceItalySpainPortugal child poverty rate before any family transfers after tax relief after cash benefits after all family transfers FGT index ( = 2) before any family transfers after tax relief after cash benefits after all family transfers The FGT index attaches greater weight to larger income gaps

Figure 1 Target efficiency of social transfers A C B D post-transfer disposable income pre-transfer disposable income households ranked by income PRE A / A+B+C PGE A / A+D poverty line

Table 13 Target efficiency of family transfers PREPGE  = 1 = 2 = 3 GREECE - cash benefits GREECE - tax relief ITALY - cash benefits ITALY - tax relief SPAIN - cash benefits SPAIN - tax relief PORTUGAL - cash benefits PORTUGAL - tax relief Greater values of  indicate greater concern for those with larger income gaps

 1. Introduction  2. Data and methodology  3. Incidence of child poverty by household type  4. Distributional impact of family transfers  5. Simulating reforms  6. Discussion and policy implications

Reforms (1)  reforming family transfers  abolish all current policies  introduce universal child benefits  what if...?

Reforms (2)  why universal child benefits?  obvious solution to the problem of gaps in coverage ... though controversial  good for illustration  easy to explain  simple to implement

Reforms (3)  which universal child benefits?  various issues involved  benefit level  variation by age  variation by no. of children etc.  5 variations of UCB reform 2 “artificial” universal child benefits  poverty-neutral / budget-neutral 3 “actually existing” universal child benefits  British / Danish / Swedish schemes adjusted in terms of average male f-t earnings

Table 14 Simulated reforms GreeceItalySpainPortugal Reform I: poverty neutral UCB Reform II: budget neutral UCB Reform III: British CB eldest other children Reform IV: Danish CB 0-3 yrs yrs yrs Reform V: Swedish CB 1 st -2 nd rd th th annual earnings male f-t employee

Table 15a Impact of simulated reforms (I): child poverty rates GreeceItalySpainPortugal child poverty rate baseline: current policy Reform I poverty neutral UCB Reform II budget neutral UCB Reform III British CB Reform IV Danish CB Reform V Swedish CB

Table 15b Impact of simulated reforms (II): intensity of child poverty GreeceItalySpainPortugal FGT index (α=2) baseline: current policy Reform I poverty neutral UCB Reform II budget neutral UCB Reform III British CB Reform IV Danish CB Reform V Swedish CB

Table 17 Winners vs. losers reform II (budget neutral CB)

Table 19 Winners vs. losers reform IV (Danish UCB)

Table 21 Fiscal effects of simulated reforms GreeceItalySpainPortugal child poverty rate baseline: current policy Reform I poverty neutral UCB Reform II budget neutral UCB Reform III British CB Reform IV Danish CB Reform V Swedish CB

 1. Introduction  2. Data and methodology  3. Incidence of child poverty by household type  4. Distributional impact of family transfers  5. Simulating reforms  6. Discussion and policy implications

Concluding remarks (1)  performance of family transfers modest  many poor families are ineligible for assistance (GR / IT) ... or receive low benefits (SP / PT)  non-refundable tax credits exclude poor families by design

Concluding remarks (2)  performance of UCBs disappointing?  replacing current policies by UCBs would not reduce the number of poor children by much – and could even increase it!  impact of UCBs weak or negative where current policies provide substantial benefits to a considerable subset of the low-income population (as in Italy)

Concluding remarks (3)  headcount poverty too severe a test for UCBs  where existing policies leave coverage gaps, those currently ineligible for assistance will be better off under a UCB even when they remain below the poverty line  headcount poverty rates cannot capture such improvements  bringing in the FGT index (implying more concern for those at the bottom of the income distribution) does more justice to the anti-poverty impact of UCBs

Concluding remarks (4)  not all UCBs are the same  the Danish UCB, paying higher amounts to younger children, emerges ahead of the others in terms of generosity and anti-poverty effectiveness  The British and the Swedish UCBs, though different in structure (the former paying a higher rate to the eldest child, the latter rising in value with family size) have similar effects on child poverty and fiscal costs

Concluding remarks (5)  playing field uneven  100% take up a reasonable assumption for universal benefits – not so for currrent income-tested policies  in favour of universal child benefits  low administrative costs  no stigma  no adverse labour incentives (i.e. no poverty traps)

Concluding remarks (6)  the case for UCB wider  horizontal redistribution  from single tax payers to families with children  children a (partly) public good  social citizenship  access to certain benefits can be a citizen right  political economy considerations  narrowly targeted programmes at risk of backlash  support for universal programmes broader-based

Concluding remarks (7)  a basic trade off at work  more generous UCBs are more effective but costlier  but: current spending on family transfers far too low  hard to reduce poverty via internal reallocations alone

Concluding remarks (8)  way forward?  judiciously combine a universal (even if low) income base...  to address the problem of gaps in coverage  to achieve horizontal redistribution... with more targeted (non-categorical) interventions  to direct extra resources to families in need  to improve effectiveness of both type I and II

Concluding remarks (9)  bring in services...  there is more to fighting child poverty than cash benefits alone  universal access to affordable, good-quality family services a high priority  a child care guarantee a promising route out of poverty

Concluding remarks (10) ... but avoid the other extreme  services a complement of cash benefits, not a substitute  proper design of income transfers still relevant!

Concluding remarks (11)  the role of microsimulation: counterfactual  “what if”-type questions  involve interactions between benefits and taxes... ... that are difficult to predict  only tax-benefit models  can provide full answers to counterfactual questions  in spite of their limitations!

Concluding remarks (12)  the role of microsimulation: aid to policy making  a valuable tool to decision making “informing” policy dilemmas promoting a more rational and dispassionate debate on tax-benefit reform