Inequality measurement and tax/transfer policy

Abstract

We provide a critique of the standard methodology for inequality measurement, which makes welfare comparisons between households by deflating household income and consumption with an equivalence scale. We argue that this leads to support for tax/transfer policies that significantly disadvantage low to middle income households and second earners—predominantly women. Its main limitations are that it takes an overly-simplistic approach to household production, bases its welfare measurements on joint household income, and has no theory of the family household. We point the way to an alternative procedure by presenting a theoretical model of the family household that derives duality-based welfare measures. In the light of current data limitations we propose, as a second best, primary earner income as a superior base to joint income for across-household welfare comparisons in policy formulation. We also emphasise the importance of taking the family life cycle into account when making such comparisons. We use the Australian income tax system and Australian income and tax data for a detailed comparison of the standard approach with our proposed alternative.