Contributions of taxes and benefits to vertical and horizontal effects

What are the relative contributions of taxes and benefits to the vertical and horizontal effects of the overall fiscal system? Interest in resolving this question was revived with the emergence of exhaustive micro-databases on household incomes that are consistently comparable across countries. However, although practitioners employ a plethora of different approaches, a completely appropriate measurement model for dissecting the contributions of taxes and benefits has not yet been developed. This paper is the first to present a systematic review of the different methods used in this field of research, and to identify their strengths and weaknesses. After the methods review, this paper introduces new decompositions of the redistributive effect into vertical and horizontal effects, based on Kakwani’s (In: Basmann RL, Rhodes GF (eds) Economics inequality: measurement and policy, pp 149–168, 1984) and Lerman and Yitzhaki’s (Rev Econ Stat 67:151–156, 1985) models, which are both widely accepted by researchers. Applications of the methodology to hypothetical and real-world data indicate the effectiveness and suitability of the new decompositions for use in cross-country comparisons of tax-benefit systems.

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