The Evaluation of Tax Reforms

Economists have found it useful to represent the variety of ways in which different ‘judges’ may evaluate a tax reform using the concept of a social evaluation function, or social welfare function. Despite its name, this makes no attempt to measure the wellbeing of society, but provides a way of determining whether any specified policy change would be considered as an improvement by an individual judge. It summarises in a succinct and convenient way the overall result of complex changes which may affect many different types of individual and household. Economists have developed methods to deal with a range of value judgements, but it cannot be expected that any single analysis would cover all possible points of view. In particular, one broad value judgement is that the overall evaluation depends on the outcomes for each individual in society - each person counts, but the importance attached to changes may not be the same for everyone (for example, depending on their income or wealth, or other circumstances considered relevant).

A general form of social welfare function, W, may thus be written as depending on some measure, say z, for each of the N persons in society. This involves a value judgement that the relevant unit of analysis is the individual.[4] Hence:

(1)

A further value judgement concerns the precise way in which z, referred to as the ‘welfare metric’, is measured and this cannot avoid value judgements as well as creating measurement problems. Alternative welfare metrics involve the use of some measure of income, or consumption, or a measure of ‘money metric utility’ which allows for the value attached to leisure. Questions also arise over the time period chosen, that is whether the welfare metric covers weekly or annual values, which are complicated by the existence of short term variations (temporary sickness or unemployment), or those measured over much longer periods, where allowance can be made for systematic life cycle variations.

In considering the welfare metric, it is common to allow for the existence of income sharing, particularly within households where there may also be economies of scale. This involves the use of adult equivalence scales, which also require value judgements to be specified; these are discussed further below. In the following analysis it is not possible to allow for the value of leisure and the welfare metric is measured in terms of income per adult equivalent person.