Piecemeal modelling of the effects of joint direct and indirect tax reforms

Capéau, B., Decoster, A., Maes, S. and Vanheukelom, T. (2018), Piecemeal modelling of the effects of joint direct and indirect tax reforms, Discussion Paper DPS 18.10, Department of Economics, KU Leuven; also available as: EUROMOD Working Paper EM 14/18.

This paper offers a framework to establish a micro-based budget and welfare evaluation of a joint reform in personal income taxes, social security contributions and indirect taxes. One often lacks an encompassing model for both labour supply decisions in real world tax and benefit contexts and the allocation of disposable income to commodities. In this paper we therefore elicit the assumptions which allow us to combine different submodels, such that an assessment of a joint reform becomes possible in a consistent conceptual framework. In addition, we characterise households' labour supply decisions by a random utility random opportunity (RURO) model of job choice. This allows us to incorporate effects from the demand side of the labour market into our analysis. We apply this framework to a recently enacted Belgian tax reform which shifts the burden away from labour taxes. We find substantial empirical evidence that, both from a distributional and from a budgetary perspective, it is important to account for indirect taxes, for labour demand--side effects and for unobserved job characteristics, when assessing this kind of joint tax reform. As for the budgetary effects, the cost recovery effects of the tax shift are modest. This is, among other things, explained by a more encompassing income effect in our job choice model, than is found in the more classic discrete choice model of labour supply.