Commitment to Equity Handbook

Estimating the Impact of Fiscal Policy on Inequality and Poverty

Nora C. Lustig

• Publisher: Brookings Institution Press
• Year: 2018
• ISBN:
  9780815732211
• Topic: Economics
• Subtopic: Economic Policy
• Index: Economics

A how-to guide for assessing the impact of fiscal policy on inequality and poverty

Inequality has emerged in recent years as a major topic of economic and political discussion, but it is often unclear whether governments can or should do something about it, and if so, what that something might be. This unique volume, edited by Nora Lustig, an equity expert at Tulane University, helps fill that void. Developed by the Commitment to Equity Institute at Tulane, the book examines both the theory and the practical methods for determining the impact of taxation and public spending on inequality and poverty. It provides a step-by-step guide for policymakers, economists, and social planners when analyzing whether fiscal policy has narrowed or widened inequality. The book also has user-written software for conducting a Commitment to Equity Assessment, along with several country studies of these assessments.

In addition to serving as a manual, the book can be used as a stand-alone reference for those interested in the methods for assessing the impact on equity of fiscal policy. It also serves as a textbook for advanced undergraduate and graduate courses on public finance and income distribution.

PART I

Methodology

Chapter 1

THE CEQ ASSESSMENT

Measuring the Impact of Fiscal Policy on Inequality and Poverty

Nora Lustig and Sean Higgins

As stated in the introduction, the purpose of this Handbook is to present a step-by-step guide to applying the incidence analysis used in Commitment to Equity (CEQ) Assessments. Developed by the Commitment to Equity Institute at Tulane University, the CEQ Assessment is a diagnostic tool that uses fiscal incidence analysis to determine the extent to which fiscal policy reduces inequality and poverty in a particular country.

The CEQ Assessment is designed to address the following four questions:

1. How much income redistribution and poverty reduction is being accomplished through fiscal policy?1
2. How equalizing and pro-poor are specific taxes and government spending?
3. How effective are taxes and government spending in reducing inequality and poverty?
4. What is the impact of fiscal reforms that change the size and/or progressivity of a particular tax or benefit?

The Handbook has been written to guide researchers and policy analysts in the completion of the CEQ Master Workbook (MWB) (available only in the Handbook’s online Part IV), a spreadsheet file that contains all the information used in a CEQ Assessment. The CEQ Stata Package (which can be installed directly through Stata) includes a suite of user-written Stata commands that automatically produces and fills out the results section of the CEQ Master Workbook.2 However, the Handbook can also be used as a stand-alone document for those interested in methodological and practical approaches to carry out fiscal incidence analysis.

This chapter presents key analytical insights in fiscal redistribution theory such as the fundamental equation that links the redistributive effect to the size and redistributive effects of taxes and benefits; how to calculate the contribution of each fiscal instrument (or combinations of them) to the change in inequality and poverty; and the implications of reranking (for the interested reader, their mathematical formulation is presented in detail in chapters 2 and 3 in this Handbook). The chapter also discusses the basics of fiscal incidence analysis used in CEQ Assessments. The CEQ Assessments rely on the fiscal incidence method known as the “accounting approach” because it ignores behavioral responses and general equilibrium effects. Because pensions frequently tend to be a combination of deferred income and government transfer, there is a section dedicated to discussing how contributory pensions should be considered in fiscal incidence analysis. Finally, the chapter describes the set of indicators used to answer the four key questions outlined above, and illustrates with examples from existing CEQ Assessments. Instructions for the implementation of a CEQ Assessment in practice are in the chapters in part II in this Handbook. Part III includes applications of the CEQ Assessment tool to specific countries and a cross-country comparison. Part IV, “The CEQ Assessment Tools,” available online only, contains the CEQ Master Workbook (MWB) (a blank version), a completed CEQ MWB for Mexico as an example, an example of “do files” in Stata for constructing the income concepts with information from Mexico, and the CEQ Stata Package with user-written software to complete the results section of the CEQ MWB. It also contains guidelines for the implementation of CEQ Assessments, including the data and software requirements, recommendations for the composition of the team, and a thorough protocol of quality control.

1 The Theory of Fiscal Redistribution: Key Analytical Insights

In this Handbook, “fiscal redistribution” refers to the process by which the state collects revenues from individuals and households (primarily through taxes) and spends these revenues on benefits (for example, cash transfers, price subsidies, and in-kind benefits such as education and health) intended for specific individuals and households. In so doing, the state changes the postfiscal income distribution and poverty rates that would have prevailed in the absence of fiscal policy. Because of behavioral responses and general equilibrium effects, fiscal policy can also change the prefiscal income distribution and poverty rates. While at this point the CEQ Assessments do not estimate the counterfactual pref...