EVALUATING TRANSFER PROGRAMS WITHIN A GENERAL EQUILIBRIUM FRAMEWORK

We set out a general equilibrium model for the evaluation of a domesticallyfinanced transfer program, which helps to combine the results from a computable generalequilibrium model with disaggregated household data. We separate the indirect welfareimpact into three components: (1) the redistribution effect arising from the need tofinance programs, (2) the reallocative effect arising from the transfer of resourcesbetween households with different “tax propensities,” and (3) the distortionary effectarising from the need to use distortionary finance instruments. We show how all theseeffects can be usefully subsumed within one parameter, namely, the cost of public funds.Using a Mexican cash transfer program as an illustration, we use the approach to showthat the substantial welfare gains that result from the switch from universal food subsidiesto targeted cash transfers reflect both the improved targeting efficiency of the latter aswell as a relaxation of the trade-off between equity and efficiency objectives whendesigning tax systems. More generally, the indirect costs of finance can be substantiallylowered when such programs are combined with appropriate tax reforms.