The Treasury

Global Navigation

Personal tools

3.2  Household Demands

The first stage in the analysis of the impact of price changes on households is to estimate the relationships between budget shares and total household expenditure for a range of household types. Household expenditure data from the Household Economic Survey (HES) for the years 1995, 1996, 1997, 1998 and 2001 were adjusted to 2001 prices using the consumer price index (CPI).[6] Over this period there were very few changes in indirect taxes. The surveys were then pooled to form one large database.

Table 2 shows the household types used.[7] In each case households were further divided into smoking (S) and non-smoking (NS) households; a positive weekly expenditure on tobacco (group 17 in Table 3) was sufficient for the household to be designated as a smoking household. The division into smoking and non-smoking households, for examination of all commodity groups, was found substantially to improve the fit of most of the budget share relationships.[8] Table 2 also gives the arithmetic mean total weekly household expenditure for each household type.

It was necessary to express all existing indirect taxes in terms of a tax-exclusive ad valorem tax rate. While this is straightforward for most commodity groups, for which only GST applies, the translation is more complex where an excise tax is also imposed, as these are typically based on units of the commodity rather than values.

It was not possible, mainly because of estimation difficulties, to use all the separate and highly detailed HES commodity categories. Instead, these were consolidated into 22 commodity groups. Table 3 shows the commodity groups used and the effective ad valorem tax-exclusive percentage rates, at 2001. The rates shown in Table 3 were taken from Young (2002). Where several HES categories were combined, the effective rates also required the computation of a weighted average of the individual components. Table 3 clearly indicates the high effective rates on petrol, cigarettes and tobacco and alcohol. These high rates are typically rationalised on merit good and externality grounds.[9]

The demand responses were calculated using the 22 commodity group classification discussed above. However, the price changes arising from the carbon tax are given for a 49 industry group classification. The calculated price changes cannot therefore be directly used to evaluate the demand responses and welfare changes. Table A4 provides the translation between the two classifications.

It may be thought that the demand model, and welfare changes, should explicitly allow for external effects. For example, suppose there is a small community in which some people hate noise and smoke, while others play loud music and burn domestic rubbish in their gardens. The people who hate smoke and noise are forced to dry their washing indoors and insulate their houses with double glazing. Taxes on smoke and noise mean that budget allocations change - those who do not need to spend on indoor drying and insulation change their allocation away from these goods.[10] Those who made noise and smoke have to spend money on devices to avoid creating the externalities, and adjust their allocations elsewhere because of income effects. Any attempt to evaluate the welfare and distributional effects of such taxes must allow for these external effects on consumption patterns and thus of course utility functions. However, the case considered in this paper is closer to a situation in which no one makes noise or smoke, but households use electricity and gas for heating and cooking. However, there are no smoke-belching coal-fired electricity generating plants near houses, and the people in the community are not aware (since it is far from visible) that their use of electricity produces effects on the air of other communities or on the ozone layer which may affect them eventually, but whose effects are remote and not evident. A tax on carbon emissions produces differential price changes for all goods according to their carbon intensities. The cleaner air elsewhere does not enter utility functions. An evaluation of the welfare and distributional effects of the tax is not subject the problems of the first case above. The government, however, believes that there are benefits to being part of an international agreement, and believes that some other communities will benefit from cleaned air. Its decision to impose the tax involves a balancing of the costs imposed by the price changes against the overall gains from emissions reductions.


Table 2 – Household Categories
No.   Household Type Number of Households Mean Weekly Expenditure
Smoking Non-Smoking Smoking Non-Smoking
1   65+ single 161 1282 267 274
2   65+ couple 224 1191 498 540
3   Single - no children 384 1098 406 437
4   Single - 1 child 148 239 400 403
5   Single - 2 children 148 181 428 438
6   Single - 3 children 59 75 468 475
7   Single - 4+ children 33 39 501 539
8   Couple - no children 966 2036 690 766
9   Couple - 1 child 381 643 668 763
10   Couple - 2 children 435 916 707 896
11   Couple - 3 children 207 458 805 844
12   Couple - 4+ children 98 195 673 822
13   3 adults - no children 319 456 975 992
14   3 adults - 1 child 122 157 898 1038
15   3 adults - 2+ children 117 134 826 920
16   4+ adults - no children 179 192 1311 1282
17   4+ adults - 1 child 65 60 1110 1129
18   4+ adults - 2+ children 47 47 1070 925
Table 3 – Commodity Groups and Tax Rates
No. Tax Rate (%)  Commodity Group HES Categories
1 12.5  Food 00-08
2 12.5  Food outside home 10
3 0  Rent 11
4 12.5  Pay to Local Authorities 13
5 12.5  House maintenance 15-17
6 12.5  Domestic fuel and power 18-30
7 12.5  Household equipment 31-32
8 12.5  Furnishings 33-36
9 12.5  Household services 37-38
10 12.5  Adult clothing 39-40,42-45,47-48
11 12.5  Children's clothing 41,46
12 12.5  Public transport in NZ 49
13 0  Overseas travel 50
14 7.05445  Vehicle purchase 51-53
15 71.776  Petrol etc 54-59
16 12.5  Vehicle supplies, parts etc 60-69
17 239.845  Cigarettes and tobacco 70-73
18 46.8191  Alcohol 74-85
19 12.5  Medical, cosmetic etc 86-88
20 12.5  Services 94-101
21 6.25  Recreational vehicles 58
22 12.5  Other expenditure 89-91,102

Notes

  • [6]Unfortunately, no surveys were carried out in 1999, 2000. or 2002.
  • [7]For the first two types, the age refers to that of the ‘head’ of the household.
  • [8]This is the relationship in equation (B8) in the Appendix.
  • [9]For a case study of alcohol, see Barker (2002).
  • [10]And, in a partial equilibrium context, only the prices of these two previously untaxed goods change.
Page top