Tax-benefits indicators from a work incentives perspective

1. Tax-benefits indicators from a work incentives perspective Comments upon Christopher Heady and Herwig Immervoll – “Rewarding Jobs: Government Policy and Work Incentives” By Paolo Sestito Economic Adviser Ministry of Labour and Social Policy - Italy

2. Comments Outline • Taxes and benefits from a labour supply perspective • Notional effective rates as a summary measure of the impact of taxes and benefits upon the relevant budget constraint faced by potential workers • When those synthetic measures make sense • Summary of potentialities and pitfalls of those summary measures • An agenda for further developments • Which indicators and how to choose among indicators • How to complement notional effective rates

3. Taxes and benefits from a labour supply perspective • Taxes and benefits reshape the whole feasibility frontier (the budget constraint) in the income/leisure space • Different slopes over different segments • Kinks and non convexities • For each individual one would need to consider the whole budget constraint • Personal and family characteristics shape the budget constraint as they impact upon both taxes and benefits. Relevant cases also depend upon individuals’ gross wage (his or her marginal product) and “tastes” (taste shifters being related to personal and family characteristics)

4. Notional effective rates as a summary measure • Average effective rates as a convexification of the budget constraint with respect to a given discrete choice (work a given amount of time/effort vs. non-work) • Marginal effective rates as measure of the local slope (piecewise linearization of the budget constraint) • The relevance of both is conditional upon the relevance of personal and family circumstances (including productivity and the gross wage one can earn in the market) and of the discrete choice/local segment under consideration.

5. When those summary measures make sense • The personal/family related circumstances have to identify empirically relevant (high supply elasticity) groups and situations: • productivity (APW levels) • Family types and individuals within families • The discrete choices and the local segments have to be empirically relevant (for the groups and situations under examination). • Notice that such an empirical relevance may depend upon the shape of the whole budget constraint (technically speaking being endogenously determined) • Dynamic considerations – including entitlement effects possibly associated to benefit schemes - have to be neglected as less relevant.

6. How far summarizing? • Average rates are already a summary measure of the whole budget constraint (whose validity depends however upon the identification of the relevant discrete binary comparisons, which depend upon the whole individual’s budget constraint and preferences) • Marginal rates are not a summary measure. One further step might then be “averaging” them over given (empirically relevant) segments of the budget constraint • However, in doing so one would need to preserve their nature of marginal rates (eg. consider the mode/median and the range of the marginal rates over the selected segment) • Summary across different cases? • Maybe, but rather cautiously and only in order to summarize countries and time periods comparisons • In any case, averaging a relatively large number of cases seems more sensible than arbitrarily picking up one given case (as unfortunately often made in the EU context!)

7. Potentialities and pitfalls • Easy and fast updates of the notional rates (possibly even with respect to planned changes whose implications may so be easily grasped) • Possible use in a benchmarking context because of the rather immediate meaning and comprehensive nature of the notional rates • However, benchmarking has to be made cautiously because of their summary nature (particularly when aggregating over different cases) • Moreover, notional rates do not provide an assessment of resources implications and redistributional impact of policy packages, issues inescapable when shaping tax and benefits systems

8. Further developments - 1 • Relevant situations/groups – common priority areas • Benefits recipients: need to take into account the (empirical) plurality of schemes and the differences usually existing over their potential duration (as a first approximation of more dynamic considerations) • Secondary earners (in the household): start from a focus upon the marginal net income implications for the household treated as an integrated decision-maker, later on taking into account of more complex decision-making structures; need to to take into account the care costs implications of the work decision? • Elderly workers: the static framework implied by the approach is not really capable to deal with these issues; on the other hand, the other approaches often implemented unrealistically assume perfect foresight and perfect capital markets • Low wage/low effort (hours) workers as high elasticity suppliers • Gross labour cost vs. earnings (net of employers’ contributions) • Marginal product linked to gross labour cost • Is self-employment so easily available to justify netting from employers contributions? • Role of perceptions and the perceived role of total (employers’+employees’) social security contributions

9. Further developments - 2 • Exploit the fast update features of the approach • Notional rates may be produced with respect to the rules normally dictated for the forthcoming year • Balance national and international perspectives • The relevant cases to be selected may differ across countries and over time, their salience possibly being affected by the tax and benefits system itself. • Tradeoff between the use of common and constant cases capable to benchmark countries and their evolution over time and the relevance of the selected indicators in each given country/time period.

10. Further developments - 3 • Need to complement notional rates with other approaches • Macro measures do not seem very sensible in order to provide indicators • Microsimulation models on the contrary may provide a better assessment of concrete policy packages (which may also be simulated assuming a balanced budget in order to focus upon redistribution/work incentives tradeoffs) and may better identify nationally relevant cases. • Microsimulation models may also simulate implications of expected socio-demographic changes. On their basis one might update weighted averages of notional rates in the far future