Abstract
We provide a critique of the standard methodology for inequality measurement, which makes welfare comparisons between households by deflating household income and consumption with an equivalence scale. We argue that this leads to support for tax/transfer policies that significantly disadvantage low to middle income households and second earners—predominantly women. Its main limitations are that it takes an overly-simplistic approach to household production, bases its welfare measurements on joint household income, and has no theory of the family household. We point the way to an alternative procedure by presenting a theoretical model of the family household that derives duality-based welfare measures. In the light of current data limitations we propose, as a second best, primary earner income as a superior base to joint income for across-household welfare comparisons in policy formulation. We also emphasise the importance of taking the family life cycle into account when making such comparisons. We use the Australian income tax system and Australian income and tax data for a detailed comparison of the standard approach with our proposed alternative.
Highlights
The use of equivalisation indices to deflate measures of household income and consumption in empirical studies of the family household has become widespread and routine, some economists have argued strongly against it.1 In practice a number of widely used equivalence scales exist
We have argued for data disaggregation as an alternative to applying the equivalisation procedure to demonstrably very heterogeneous households, at least for tax/transfer policy analysis, since the procedure serves to conceal differences in characteristics that are important for this purpose
In this paper we have presented a critique of the standard methods of using equivalence scales to make across-household welfare comparisons
Summary
The use of equivalisation indices to deflate measures of household income and consumption in empirical studies of the family household has become widespread and routine, some economists have argued strongly against it. In practice a number of widely used equivalence scales exist. The equivalisation procedure, when based on standard demographic variables, assumes that the components of the household type vector are fully observed, and rules out consideration of the implications of the fact that important components of this vector may not be observable, or, more accurately, not currently available in existing datasets This has to do with the absence of a conceptual framework for family household decision taking of the kind we provide in this paper. Our main focus is on across-household inequality measurement, with the aim of showing that household equivalence scales are both unnecessary and misleading They offer support for tax/transfer policies that make low-to-middle income households and second earners - predominantly women - in those households significantly worse off than they would be under alternative policies. This leads us to describe the kinds of data collection that should take place to allow more comprehensive measures to be constructed
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