Relative welfare weights for individuals, consumers and producers

Vol: 
6/2017
Author name: 
Varela P
Year: 
2017
Month: 
September
Abstract: 

This paper applies the concept of an Inequality Deflator to evaluate the relative value of capital versus individual income. As the shareholders of businesses are typically higher income earners than the average person (and the typical consumer), money transferred to business owners or shareholders will, on average, increase the level of inequality in an economy. To the extent that society values both equity and efficiency goals, benefits accruing to businesses should be less valuable than benefits accruing to a typical individual (or a typical consumer). The Inequality Deflator, when applied to capital earnings, can be interpreted as the amount of money that would be received by everyone if the income tax and transfer system were used to redistribute a dollar earned by a business evenly across the population. This paper estimates the relative welfare weights based on the Inequality Deflator for the United States and for Australia and finds that once distributional differences are adjusted for, a benefit of \$1 to a business is equivalent to around 97 cents to a typical consumer (weighted by consumption) and around 88 cents to a typical individual. The paper can also be used to improve welfare calculations in the sufficient statistics welfare literature, which typically assumes that a dollar transferred between a consumer and a producer has no net welfare effects and can therefore be ignored. However, once distributional effects are considered, the incidence of the tax (whether it falls on producers or consumers) has welfare effects.

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