Distributional and Poverty Effects of Income Tax

Reform in Serbia

Sasa Randjelovic

Jelena Zarkovic Rakic

University of Belgrade – Faculty of Economics

Foundation for Advancement of Economics

World Bank Conference: “Poverty and Inclusion in Western Balkans”

Brussels, 14 December 2010

Outline

Rationale for the research

Literature review

Data and methodology

Results ...effects on inequality ...effects on vertical equity ...effects on poverty

Conclusion

Rationale for the research

Current income tax in Serbia – inefficient and inequitable

Income tax reform on the top of policy agenda Several reform scenarios are being considered

Aim of our paper: Ex-ante analysis of distributional, vertical equity and poverty

effects of two reform scenarios

Literature review

Distributional effects of income tax reform was subject to numerous empirical researches ...usually, by means of microsimulation analysis

...in Western Europe and North America: Decoster, et. al. (2008) – Belgium Fuest, et. al. (2008) - Germany Jacobs, et. al. (2007) – the Netherlands Diaz-Gimenez (2007) – the USA

...in Central and East Europe: Paulus, et. al. (2009) – Estonia, Hingary, Slovenia

Data and methodology EUROMOD – European Tax & benefit microsimulation

model, developed by the University of Essex (the UK) 19 EU member states (15 old + 4 new member states)

...the model for the remaining 8 EU member states is currently being developed

Advantage to national MSMs: enables comparative analysis accross countries

Data and Methodology

SRMOD – microsimulation model for Serbia The first model of that kind outside the EU Developed on EUROMOD platform (2009-2010.) Authors: University of Belgrade (FREN) research team

(Arandarenko, Avlijaš, Ranđelović, Žarković Rakić, Vladisavljević)

Plans: formal integration in EUROMOD, development of microeconometric labour supply model, application...

Dataset used in SRMOD: Living Standard Measurement Survey 2007

Survey performed by the Statistical Office of Serbia Sample: 5,557 households, 17,375 individuals

Rational for income tax reform and possible scenarios

Current income tax system in Serbia: Mixed (hybrid) model, with strong scheduler component Disadvantages: lack of equity (both horizontal and verical), limited

redistributive effects

Flat, dual or comprehensive income tax reform?

Revenue neutral reform scenarios

Flat Tax Comprehensive income tax

Taxable income Sum of income from all sources

Tax base Taxable income decreased by deductions

Deductions Personal – RSD 9,000

Dep. children – RSD 4,000

Personal – RSD 15,000

Rate(s) 15% Progressive – 12% and 22%

Results: What would be the impact of the reform on income distribution

(Gini approach)?Current PIT

Flat tax Comprehensive income tax

Gini coeff. – market income 0,470 0,470 0,470

- effects of income tax on Gini -0,008 -0,012 -0,015

- effects of SSC on Gini coeff. -0,003 -0,004 -0,005

- effects of benefits on Gini coeff. -0,108 -0,107 -0,107

Gini coeff. – disposable income 0,351 0,347 0,343

Inequality would decrease after income tax reform Comprehensive income tax reform would trigger somewhat larger

redistribution, than flat tax ...but redistributive power or tax system still modest

Results: Who would be better-off and who would be worse-off after income

tax reform?

Under both scenarios – redistribution from the richest to the middle class Compreh. tax provides better structure of redistribution No possitive effects on the poorest

Graph 1: Change in disposable income per decile groups after tax reform

-0,8%-0,6%-0,4%-0,2%0,0%0,2%

1 2 3 4 5 6 7 8 9 10

Flat tax Comprehensive income tax

Results: Poverty effects of tax reform?

Very limited effects on poverty Disposable income of bottom decile is not to change

Table 4: Effects of tax reform on poverty

Current income tax system

Flat tax Comprehensive

income tax

Total 10.7 10.5 10.5

0-15 13.0 12.7 12.7 16-29 11.9 11.6 11.6 30-44 10.5 10.4 10.4 45-64 11.4 11.2 11.2 65+ 8.6 8.5 8.5

Man 10.4 10.3 10.3 Women 10.9 10.7 10.7

1) Poverty line is set at 40% of disposable income

Results: Vertical equity effects of tax reformGraph 2: Average tax rate per decile groups

0%

2%

4%

6%

8%

10%

1 2 3 4 5 6 7 8 9 10

Current income tax system Flat tax Comprehensive income tax

Graph 3: Musgrave-Thin progressivity index under various income tax scenarios

1.0221.029

1.015

1,0051,0101,0151,0201,0251,0301,035

Current income taxsystem

Flat tax Comprehensive incometax

Increase in progressivity (vertical equity) CIT more progressive than

the flat tax ...but still much less than

OECD average (M-T index of 1.08)

Concluding remarks

Both reform scenarios reduce inequality and improve vertical equity CIT more effective than flat tax

Redistribution from the richest to the middle class CIT triggers somewhat better structure of redistribution

Very limited effects on reduction of poverty Due to lack of change in disposable income of bottom decile

Further research Distributional effects of dual income tax? Efficiency effects of various income tax reform scenarios