Distributional analysis is often used to assess the impacts of a policy on households. This analysis is often picked up on in wider debates. Distributional analysis involves grouping all households in the population into buckets, ordered from the lowest income to highest. Subsequently, the average effect of the policy for each bucket is then shown. This type of analysis is used to test whether a policy change is progressive. In other words, whether the policy has a more positive impact on poorer households than on richer households.
Distributional analysis has several obvious benefits. It reduces the relatively complicated question of “progressiveness for a given metric” to a visually clear and accessible chart. For example, in the UK, the Institute for Fiscal Studies conducted election manifesto analysis which was just such a chart. The chart was used to show the distributional impact of all tax and benefit proposals from the manifestos of the Liberal Democrat, Conservative, and Labour.
Distributional analysis is quite effective in evaluating and assessing impacts that can be measured reasonably and unambiguously, in a monetized form. Also, all distributional analysis is essentially used to simulate a number of scenarios. One of the scenarios is treated as a baseline and all the others as counterfactual. The total difference observed with the baseline scenario is just the estimated impact of a specific counterfactual scenario.
Why is distributional analysis important?
When a policy is introduced by any government, different groups including those with protected characteristics, are likely to gain or lose more than others. Distributional analysis can help determine the following in such cases:
- Whether the policies achieve the set objectives
- Whether the policies are consistent with the overarching strategies
- Whether social criteria such as equality and fairness are met
Distributional analysis is the tool of choice when it comes to large-scale and long-term policies, like those pertaining to the budget. A model called microsimulation is used in these analyses. This model is essentially a set of relationship between major variables that allows the analyst to estimate the effect of a policy on households, individuals, or other micro-units.
The microsimulation model compares a baseline scenario (excluding the policy) against a counterfactual scenario (including the policy). It does this to isolate the effects of the policy from those changes which would have occurred in the absence of the policy. A microsimulation model can be classified into two:
- Static – In a static microsimulation model, the relationship between the variables do not change when the policy is introduced
- Dynamic – Dynamic microsimulation means that those relationships can change because households are predicted to alter their behavior.
Distributional analysis is mostly used to estimate the effects of direct taxes and its benefits on individuals with different levels of income.
Distributional Analysis Models
There are a wide range of microsimulation models that exist. We have discussed some of them used in the UK below:
- Models used in Scotland
The Scottish government published an article dubbed “The Role of Income Tax in Scotland’s Budget.” This article provided distributional analysis by income of various tax proposals on individuals. The government used the Income Tax Model to estimate the impacts it would have on individuals. The income tax model is based on a population forecast, macroeconomic forecasts, and other data sources. It is a static model. However, behavioral responses are added in a second stage by applying taxable income elasticities. The income tax model is used in Scotland to perform distributional analysis changes to income tax policy on gender and age groups.
On the other hand, the Scottish government used the Tax and Welfare Model to estimate the impacts on households. This is also a static model that is based on the Family Resources Survey (FRS). The tax and welfare model can include benefits. It can also be adapted to consider the protected characteristics included in the FRS. The government used this model to perform distributional analysis of changes to income tax policy for households by income and disability status. Although the tax welfare model does not incorporate indirect taxes or public services, it can be extended to do so with varying degrees of difficulty. For instance, it would be easier to incorporate VAT than corporation law.
Other models in the UK
- Tax Transfer Model
- Intra-government Tax and Benefit Model
- Policy Simulation Model
- IFS’s TAXBEN Model
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