Distributional and Poverty Effects of Income Tax Reform in Serbia Sasa Randjelovic Jelena Zarkovic Rakic University of Belgrade – Faculty of Economics Foundation for Advancement of Economics World Bank Conference: “Poverty and Inclusion in Western Balkans” Brussels, 14 December 2010

Outline Rationale for the research Literature review Data and methodology Results ...effects on inequality ...effects on vertical equity ...effects on poverty Conclusion

Rationale for the research Current income tax in Serbia – inefficient and inequitable Income tax reform on the top of policy agenda  Several reform scenarios are being considered Aim of our paper:  Ex-ante analysis of distributional, vertical equity and poverty effects of two reform scenarios

Literature review Distributional effects of income tax reform was subject to numerous empirical researches ...usually, by means of microsimulation analysis...in Western Europe and North America:  Decoster, et. al. (2008) – Belgium  Fuest, et. al. (2008) - Germany  Jacobs, et. al. (2007) – the Netherlands  Diaz-Gimenez (2007) – the USA...in Central and East Europe:  Paulus, et. al. (2009) – Estonia, Hingary, Slovenia

Data and methodology EUROMOD – European Tax & benefit microsimulation model, developed by the University of Essex (the UK)  19 EU member states (15 old + 4 new member states)...the model for the remaining 8 EU member states is currently being developed  Advantage to national MSMs: enables comparative analysis accross countries

Data and Methodology SRMOD – microsimulation model for Serbia  The first model of that kind outside the EU  Developed on EUROMOD platform ( )  Authors: University of Belgrade (FREN) research team (Arandarenko, Avlijaš, Ranđelović, Žarković Rakić, Vladisavljević)  Plans: formal integration in EUROMOD, development of microeconometric labour supply model, application... Dataset used in SRMOD:  Living Standard Measurement Survey 2007 Survey performed by the Statistical Office of Serbia Sample: 5,557 households, 17,375 individuals

Rational for income tax reform and possible scenarios Current income tax system in Serbia:  Mixed (hybrid) model, with strong scheduler component  Disadvantages: lack of equity (both horizontal and verical), limited redistributive effects Flat, dual or comprehensive income tax reform? Revenue neutral reform scenarios Flat TaxComprehensive income tax Taxable incomeSum of income from all sources Tax baseTaxable income decreased by deductions DeductionsPersonal – RSD 9,000 Dep. children – RSD 4,000 Personal – RSD 15,000 Rate(s)15%Progressive – 12% and 22%

Results: What would be the impact of the reform on income distribution (Gini approach)? Current PIT Flat taxComprehensive income tax Gini coeff. – market income0,470 - effects of income tax on Gini-0,008-0,012-0,015 - effects of SSC on Gini coeff.-0,003-0,004-0,005 - effects of benefits on Gini coeff.-0,108-0,107 Gini coeff. – disposable income0,3510,3470,343 Inequality would decrease after income tax reform  Comprehensive income tax reform would trigger somewhat larger redistribution, than flat tax ...but redistributive power or tax system still modest

Results: Who would be better-off and who would be worse-off after income tax reform? Under both scenarios – redistribution from the richest to the middle class  Compreh. tax provides better structure of redistribution  No possitive effects on the poorest

Results: Poverty effects of tax reform? Very limited effects on poverty  Disposable income of bottom decile is not to change

Results: Vertical equity effects of tax reform Increase in progressivity (vertical equity)  CIT more progressive than the flat tax ...but still much less than OECD average (M-T index of 1.08)

Concluding remarks Both reform scenarios reduce inequality and improve vertical equity  CIT more effective than flat tax Redistribution from the richest to the middle class  CIT triggers somewhat better structure of redistribution Very limited effects on reduction of poverty  Due to lack of change in disposable income of bottom decile Further research  Distributional effects of dual income tax?  Efficiency effects of various income tax reform scenarios