Indexing Out of Poverty? Fiscal Drag and Benefit Erosion in Cross‐National Perspective

Abstract

We assess how tax-benefit policy developments in 2001-11 affected the household income distribution in seven EU countries. We use the standard microsimulation-based decomposition method, separating further the effect of structural policy changes and the uprating of monetary parameters, which allows us to measure the extent of fiscal drag and benefit erosion in practice. The results show that despite different fiscal effects, policies overall mostly reduced poverty and inequality and both types of policy developments had sizeable effects on the income distribution. We also find that the uprating of monetary parameters not only had a positive effect on household incomes, meaning fiscal drag and benefit erosion were avoided, but generally also contributed more to poverty and inequality reduction than structural policy reforms.JEL Codes: D31, H23, I32 Toon Vanheukelom and participants at workshops (Canazei, Colchester, Seville) and conferences (ImPRovE, Antwerp; SEEK, Mannheim; EALE, Ljubljana; IMA, Maastricht). The results presented here are based on EUROMOD version F6.36. EUROMOD is maintained, developed and managed by ISER at the University of Essex, in collaboration with national teams from the EU member states. We are indebted to the many people who have contributed to the development of EUROMOD. The process of extending and updating EUROMOD

Europe Through the Crisis: Discretionary Policy Changes and Automatic Stabilizers

“…If actual tax-benefit parameters were increased slower (faster) than prices, tax liabilities would go up (down) due to bracket creep and benefit entitlements would fall (rise) due to benefit erosion. See Paulus et al (2019) for more discussion on the choice of and its implications for the measured policy effect. In turn, by keeping tax-benefit policies fixed (at t = 0 values in Equation (1)), the other effect captures changes in (real) market incomes and the characteristics of the population (e.g.…”

“…Taylor, 2000;Feldstein, 2002;Blanchard and Perotti, 2002;Fatás and Mihov, 2003;Auerbach and Gorodnichenko, 2012;Caggiano et al, 2015;Miyamoto, Nguyen and Sergeyev, 2018). But a large body of microeconomic literature has shown their importance for the income distribution, for example, Clark and Leicester (2005); Sefton and Sutherland (2005); Sutherland et al (2008); Bargain (2012) for the UK; Decoster et al (2015) for Belgium; Matsaganis and Leventi (2014); De Agostini, Paulus and Tasseva (2016); Bargain et al (2017); Hills et al (2019); Paulus, Sutherland and Tasseva (2019) for selected EU countries. A decomposition approach combined with a tax-benefit calculator and household micro-data has enabled researchers to identify the direct (non-behavioural) impact of policy changes on the income distribution.…”

Assessing the distributional impact of budgetary policy: the role of benchmarks and indexation

“…When, as has usually been the case, nominal wage growth is faster than price inflation, there are similar issues in terms of relative income: if benefit rates do not keep pace with growth in real incomes, then the incomes of those dependent on welfare fall in relation to average living standards. Paulus et al (2019) term this 'benefit erosion'.…”

Effects of tax-benefit policies on the income distribution and work incentives in Estonia

“…The choice of the indexation factor, p, can have a significant impact on results (Paulus et al, 2019). Like in De Agostini et al 2015, 2016, and Paulus and Tasseva (2018), changes in consumer price indices (CPI) and nominal growth in average market incomes (MII) are used to index policy parameters in the counterfactual scenario.…”

“…However, at times when real market incomes were growing, such policies would lead to households who are more reliant on benefit or pension income to fall behind those relying mainly on market incomes. Inequality would likely increase and the government's fiscal balance would improve as a result of the so-called fiscal drag (Immervoll, 2005;Paulus et al, 2019).…”