The exact measurement of the welfare costs of tax and price reform requires a detailed knowledge of individual preferences. Typically, first-order approximations of welfare costs are calculated avoiding detailed knowledge of substitution effects. The authors derive second-order approximations which, unlike first-order approximations, require knowledge of the distribution of substitution elasticities. This paper asks to what extent simple approximations can be used to measure the welfare costs of tax reform and evaluates the magnitude of the biases for a plausible size tax reform. In the authors' empirical examples, first-order approximations display systematic biases; second-order approximations always work well.
Authors
CPP Co-Director
James is Senior Research Fellow and Professor of Economics at Manchester, working on broad issues in the economics of retirement, savings and health.
CPP Co-Director
Richard is Co-Director of the Centre for the Microeconomic Analysis of Public Policy (CPP) and Senior Research Fellow at IFS.
Research Associate Boston College
Arthur is a Research Associate of the IFS and holds the Barbara A. and Patrick E. Roche chair in economics at Boston College.
Journal article details
- Publisher
- Royal Economic Society
- Issue
- January 1996
Suggested citation
J, Banks and R, Blundell and A, Lewbel. (1996). 'Tax reform and welfare measurement: do we need demand system estimation?' (1996)
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