Decomposition analysis of distributive policies using behavioural simulations

For policy makers and analysts, it is important to isolate the redistributive impact of tax-benefit reforms from changes in the environment in which policies operate. When actual reforms are motivated by work incentives, it is also crucial to evaluate behavioural responses and the distributional consequences thereof. For that purpose, I embed counterfactual simulations in a formal decomposition framework to quantify the relative roles of (i) direct tax-benefit policy changes, (ii) indirect policy effects due to labour supply responses to the reforms and (iii) all other factors affecting income distribution over time. An application to the UK shows that the redistributive reforms of the 1998–2001 period have offset much of the rise in market income inequality and contributed to a strong decline in child poverty and poverty amongst single parent households. In the latter group, a third of the headcount poverty reduction (and half of the reduction in the depth of poverty) is on account of the very large incentive effect of the policy changes. Copyright Springer Science+Business Media, LLC 2012