Comparing Tax and Transfer Systems: How Might Incentive Effects Make a Difference?

This paper compares a stylized version of a basic income flat tax system (BI/FT) with a means tested graduated tax system (MT/GT), with particular attention paid to potential labor supply effects of taxes. A highly simplified simulation model is developed in which individuals are homogeneous except for the wage they face, and there is a single means-tested benefit. In this model, moving towards universal benefits can raise labor force participation and such effects can outweigh the labor supply reductions of working taxpayers. The number of losers is found to be quite small relative to the number of winners. If a fully universal system is not adopted, a move towards it, by reducing the taper on means tested benefits at the expense of a higher tax rate, can lead to significant winners without losers. These findings do not appear to be sensitive to assumptions about the individuals' utility function defined over income and leisure. Copyright 2002 by The Economic Society of Australia.