Comparing Welfare Change Measures with Income Change Measures in Behavioural Policy Simulations

John Creedy, Nicolas Hérault and Guyonne Kalb

No 1030, Department of Economics - Working Papers Series from The University of Melbourne

Abstract: This paper presents a method of computing welfare changes (compensating and equivalent variations) arising from a tax or social security policy change, in the context of behavioural microsimulation modelling where individuals can choose between a limited number of discrete hours of work. The method allows fully for the nonlinearity of the budget constraint facing each individual, the probabilistic nature of the labour supply model and the presence of unobserved heterogeneity in the estimation of preference functions. An advantage of welfare measures, compared with changes in net incomes, is that they take into account the value of leisure and home production. The method is applied to hypothetical income tax policy changes in Australia and comparisons are made at the individual and the aggregate level. At the aggregate level a social welfare function is specified in terms of money metric utility. It is shown that policy evaluations based on welfare changes can be substantially different from those using only individuals' net income changes.

Keywords: Welfare change measures; equivalent variation; compensating variation; labour supply modelling; non linear budget constraint (search for similar items in EconPapers)
JEL-codes: D63 H31 J22 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2008
New Economics Papers: this item is included in nep-hap
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Citations: View citations in EconPapers (2)

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Related works:
Working Paper: Comparing Welfare Change Measures with Income Change Measures in Behavioural Policy Simulations (2007)
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