Distributional impact of alternative financing of social security

1
Distributional impact of alternative financing of
social security

• André Decoster
• Centrum voor Economische StudiënKULeuvenm.m.v.
• Bart Capéau, Kris De Swerdt, Kristian Orsini
• Gerre Verbist
• Centrum voor Sociaal Beleid Herman
  DeleeckUniversiteit Antwerpen
• Seminarie FOD Sociale Zekerheid 13 februari 2006

2
Structure of the exposition

1. Some insights from tax theory
2. Empirical assessment
3. incidence analysis of indirect taxes (ASTER)
4. incidence analysis of social security
   contributions (MISIM)
5. effect of one scenario of shifting financing
   social security from employee contributions to
   indirect taxes
6. Summary and plans for further research

3
Focus of the analysis

• only one alternative source indirect tax
• more specifically VAT
• but policy relevant (Germany)

4
Insights from a theoretical perspective
tax on income from capital (on savings)
tax on labour income

• is unjust
• distorts labour/capital choice

is a distortion causing problems
remove this tax
remove this tax
5
Insights from a theoretical perspective

• there is a revenue constraint separate
  discussion about size of government, amount of
  public goods
• about distortion in absence of lump sum
  instrument (first best), there is indeed a
  welfare cost associated with taxation (second
  best)
• e.g. labour income tax changes relative price
  consumption/leisure and induces changes in this
  choice, can be expressed as efficiency loss of
  collecting revenue
• But insight modern public finance in second best
  world, removing one single distortion does not
  necessarily improve the situation (or you do not
  minimize welfare loss by minimizing number of
  distortions)

6
Insights from a theoretical perspective

• therefore question becomes is shift from labour
  income tax to indirect tax welfare improving
• from efficiency point of view (less excess
  burden)
• from distributional point of view
• what is the difference between labour income tax
  and indirect tax?
• if proportional, and no other income NONE!
• based on fundamental identity
• income spending

7
Insights from a theoretical perspective
tax on labour income
tax on consumption
8
Insights from a theoretical perspective

• Example

9
Insights from a theoretical perspective

• equivalence implies
• one does not remove the distortion from the
  income tax by switching from labour income tax to
  a uniform commodity tax
• using proportional commodity taxes amounts to
  removing the progressivity of the (labour) income
  tax
• Optimal Tax-theory
• distortion (of labour income tax) might be
  decreased by differentiating the indirect tax
  structure taxing complements with leisure at a
  higher rate
• might be more efficient to redistribute by means
  of differentiated indirect tax than by means of
  progressive income tax
• Conclusion simplistic argument remove
  distortion does not hold

10
Insights from a theoretical perspective

• what about taxation of savings?
• income spending saving
• intertemporal model is needed
• uniformity result not taxing saving (expenditure
  tax)
• why depart from uniformity?
• efficiency arguments (new distortion relative
  price between consumption now and consumption
  later is changed)
• distributional considerations weight attached to
  different generations

11
Insights from a theoretical perspective
conclusion

• theoretical arguments point in different
  directions
• it is the joint effect of all distortions that
  matters, unilaterally removing just one (or a
  few) does not necessarily lead to welfare
  improvement
• Pareto-improvements (which are at the core of the
  theoretical analysis) depend on the initial
  situation. This is not necessarily the real world
  situation
• Distributional concerns matter
• Hence empirical assessment through simulation
  experiment is valuable

12
Structure of the exposition

1. Some insights from tax theory
2. Empirical assessment
3. incidence analysis of indirect taxes (ASTER)
4. incidence analysis of social security
   contributions (MISIM)
5. effect of one scenario of shifting financing
   social security from employee contributions to
   indirect taxes
6. Summary and plans for further research

13
Empricial assessment MISIM and ASTER combined
Labour cost
Employer contributions
Gross incomes
Employee contributions
PIT
SEP
Net incomes
Budget survey
Indirect taxes
Indirect taxes
detailed consumption taxes
detailed consumption taxes
MISIM
ASTER
14
Incidence of indirect taxes

• indirect tax structure differentiates between
  commodities
• which interacts with the differentiated
  consumption patterns of households
• we use the budget survey of 2001
• to show these expenditure patterns
• and hence the variation in indirect tax burden

15
of total expenditures subjected to different
VAT-rates (NIS Budget Survey 2001)
16
Structure of total expenditures (average income
shares)
17
Structure of expenditures

• conceals considerable heterogeneity across
  households
• e.g. variation in function of disposable income
• share of food

18
income share of food expenditures (NIS budget
survey 2001)
19
income share of food expenditures (NIS budget
survey 2001)

• might be explained by
• income
• household size
• age of hh members
• many other characteristics
• preferences in general

20
Stylized representation of food share
21
Non parametric estimations of income shares
(Kernel)

• Hence, to impute an expenditure structure in a
  dataset without expenditures (e.g. CSB), we need
  to estimate this relationship
• is done by means of econometric estimation in
  which following explanatory variables help to
  explain the income shares
• disposable income
• household composition (size, age)
• region
• there remains unexplained variation

22
Estimation of income share domestic fuel oil
23
estimation of income share saving
24
Some Kernel-Engelcurves (income shares)
25
Some Engelcurves
26
Some Engelcurves
27
Result 1 of expenditures in VAT-classes (by
decile)
28
Result 2 Incidence of VAT by decile
29
Incidence of Excise by decile
30
Incidence of indirect tax (VATexcise) by decile
31
MISIM

• MIcroSImulationModel of social security and
  personal income tax
• developed by the Centre for Social Policy
• On the basis of data of Socio-Economic Panel
  (SEP) 1997, indexed up to 2005
• Policy rules of August 2005 for calculation of
• social security contributions of employer
• social security contributions of employee
• personal income tax

32
Calculation contributions employer

• contribution employer for private and public
  sector
• private sector difference between blue and white
  collar, and number of employees is taken into
  account
• reduction of contribution employer
• structural reduction (in MISIM)
• specific reductions (only partially in MISIM)
• other reductions (not in MISIM)

33
Calculation contributions employee

• Own contributions for public and private sector
• 13.07 in private sector and public sector
  without tenure contract (blue/white collar)
• 11.05 civil servants
• reduction for low labour incomes (werkbonus)
• own contributions for self-employed
• contributions on replacement incomes (pensions,
  sickness and invalidity)

34
Distribution by decile of welfare (MISIM
2005)(private and public sector, self-employed)
35
Employees contribution on gross wage by decile
36
Self-employed contribution on gross labour
income by decile
37
Replacement incomes contribution on gross
pension by decile
38
Scenario for alternative financing of Social
Security

• Gross wage
• Contribution 13.07 (private) / 11.05 (public)
• Reduction -15
• application of workbonus
• Taxable income
• Personal income tax
• Net disposable income
• Note own contributions self-employed and
  replacement incomes do not change!

39
Scenario for alternative financing of Social
Security

• Only effect (and direct) disposable income, not
  on labour cost (and hence labour demand)
• labour demand perfectly elastic (horizontal)
• No effect on labour supply (preliminary)
• labour supply perfectly inelastic (vertical)
• Revenue neutrality by increase of indirect taxes
  (VAT, not excises)
• Behavioural reactions through budget shares that
  respond on change in disposable income

40
Revenue neutrality
Million
reduction of contributions employees -1675
increase in income taxes 876
net cost -798

• Increase VAT to collect additional revenu of 0,8
  bn ?
• No, since ASTER only captures VAT-receipts from
  consumption by private households
• Ratio ASTER VAT/Total VAT67
• Hence increase VAT to get 0.67x798 535 million
  

41
Revenue neutrality

• scenarios to collect the 535 million

Mio
increase all VAT-rates by 5 (6,3 and 22,1) 468
increase all VAT-rates by 6 (6,7 and 23,4) (A) 550
increase the 21-rate to 22 364
increase the 21-rate to 23 (B) 669
42
Change in consumer price for scenario A and B
43
Change in consumer price for scenario A and B
44
Evaluation for each household

• income change disposable income of those who
  earn labour income as employee increases
• price change to buy the same bundle of
  commodities, one needs more income
• average effect for the two scenarios ( of 2005)

A 6.3 22.1 B 21 to 23
income change 197 (0,74) 197 (0,74)
price change (loss) 145 (0,54) 196 (0,74)
total welfare effect 52 (0,19) 0
45
Income and price change by decile Scenario A
46
Income and price change by decile Scenario B
47
welfare change by decile Scenario B
48
Income and price change by socio-professional
group Scenario B
49
welfare change by socio-professional category
Scenario B
50
Caveats

• Labour supply reaction not taken into account
• but research in other context might be small
• preliminary research on PSBH-dataset by means of
  discrete choice model of labour supply (only for
  couples)

Baseline (1000) change (units)
employment men 1,603 4385 0.27
employment women 1,255 3461 0.28
hours men 69,176 273031 0.39
hours women 38,798 150206 0.39
51
Caveats

• Labour supply reaction
• increase in disposable income might be too small
• also labour supply reaction is different across
  deciles more than 40 of the increase in
  employment occurs in the bottom decile
• welfare gain of increased employment not only
  income (or consumption) changes, but also
• change in leisure time
• welfare effect of social inclusion

52
Caveats

• Labour supply reaction not taken into account
• Labour demand effects might be more important
• currently (research) trade-off between using a
  model with detailed distributional effects and
  one which models both sides of labour market (or
  more generally traditional macro, CGE)
• frontier of research on micro-macro links

53
Conclusion

• revenue neutrality cannot be discarded in the
  debate
• nonsens remains nonsens (some) equivalence
  between labour income taxation and commodity
  taxes
• hence, importance of distributional assessment
• intuition about important distributional
  consequences is confirmed
• important intergenerational aspects