A method for decomposing the impact of reforms on the long-run income distribution, with an application to universal credit

Mike Brewer,Robert Joyce,Tom Waters,Joseph Woods

doi:10.1016/j.econlet.2020.109230

Mike Brewer, Robert Joyce + Show 2 more

Open Access

https://doi.org/10.1016/j.econlet.2020.109230

Copy DOI

Abstract

Income inequality, as well as the impact of tax and benefit reforms on it, has typically been evaluated with respect to ‘snapshot’ incomes, measured over short periods such as one week or year. But longitudinal data allows long-run measures of income to be used, which will be of interest to policymakers interested in persistent, rather than only temporary, poverty. We show that the long-run distributional impact of a reform is the combination of three effects: a ‘static’ effect, which would be observed if individuals’ circumstances were consistent throughout their life; an ‘income dynamics’ effect, resulting from individuals moving around the income distribution over time; and a ‘tagging’ effect, resulting from the reform affecting individuals differently according to whether they have a characteristic predictive of long-run income conditional on current income. We propose a simple method to decompose these three effects for any inequality, poverty, or distributional statistic. We use the method to examine the distributional impact of the introduction of ‘Universal Credit’, the most important reform to the UK benefit system in decades. We show that Universal Credit is less regressive on a long-run basis than a snapshot one, partly because of income dynamics but also because it reduces entitlements for (or ‘negatively tags’) those who are more likely to find a period of low income to be temporary, rather than persistent.

Highlights

Analysis of the distributional impacts of tax and transfer policies has traditionally examined the effects on incomes measured over short periods (a ‘snapshot’), typically a week or year (e.g. Hoynes and Rothstein, 2019; Figari et al, 2015; Congressional Budget Office, 2019)
This is because people move around the income distribution over time, attenuating the long-run differences in how people are affected by a reform
The UK is in the process of a radical benefit reform, with a single integrated payment – Universal Credit (UC) – replacing the six main means-tested working-age benefits, and changing entitlements for 76% of those entitled (Brewer et al, 2019)

Summary

Introduction

Analysis of the distributional impacts of tax and transfer policies has traditionally examined the effects on incomes measured over short periods (a ‘snapshot’), typically a week or year (e.g. Hoynes and Rothstein, 2019; Figari et al, 2015; Congressional Budget Office, 2019). Researchers are increasingly using longitudinal data to evaluate distributional impacts on long-run measures of income (e.g., Huggett and Parra, 2010; Brewer et al, 2012; Levell et al, 2016; Haan et al, 2017; Bartels and Neumann, 2018; Roantree and Shaw, 2018) Both of these sorts of analyses tell us something important. We propose a method to decompose the long-run progressivity of a reform into these three components Disentangling these impacts is useful because (absent behavioural response) tagging is the only way policymakers can change the long-run distributional consequences of a policy package for a given snapshot effect. To highlight the usefulness of this approach we analyse several policy reforms, including the transition in the UK to ‘Universal Credit’ (UC), the most important reform to the UK benefit system in decades, and one with sizable tagging effects

Method

Analysis of reforms

Universal credit

Findings

Conclusion