Analysing the Effects of Tax-benefit Reforms on Income Distribution: A Decomposition Approach

To assess the impact of tax-bene?t policy changes on income distribution over time, we suggest a methodology based on counterfactual simulations. We start by decomposing changes in inequal- ity/poverty indices into three contributions: reforms of the tax-bene?t structure (rules, rates, etc.), changes in nominal levels of market incomes and tax-bene?t parameters (bene?t amounts, tax bands, etc.), and all other changes in the underlying population (market income inequality, demographic composition, employment level, etc.). Then, the decomposition helps to extract an absolute measure of the impact of tax-bene?t changes on inequality when evaluated against a distributionally-neutral benchmark, i.e. a situation where tax-bene?t parameters are adjusted in line with income growth. We apply this measure to assess recent policy changes in twelve European countries. Finally, the full decomposition allows quantifying the relative role of policy changes compared to all other fac- tors. We provide an illustration on France and Ireland and check the sensitivity of the results to the decomposition order.