A model of labour supply is used to calculate Australia's marginal cost of public funds, which is the appropriate cut‐off benefit/ cost ratio for an additional public project. The labour supply model incorporates effective average and marginal tax rates faced by the representative household in each gross income decile. These rates are estimated from the ABS 1988–89 Household Expenditure Survey. A simulation analysis is performed to calculate the effect on labour supply of a 1 per cent increase in marginal tax rates. The estimated changes in tax revenues and deadweight loss in each decile are used to estimate the marginal cost of public funds.
The households included in the 1988-89 ABS Household Expenditure Survey were grouped according to size, degree of labour force participation, and weekly household private income. Households at similar levels of income were then compared to determine the effect on disposable income of a small increase in labour market earnings, resulting in higher taxes paid and lower benefits received. A wide range of direct and indirect taxes and direct and indirect benefits was included in the calculation. Effective marginal tax rates were calculated as the ratio of increased taxes plus reduced benefits to the postulated increase in earnings. Effective marginal tax rates were found to be generally higher for households in the bottom half of the household disposable income distribution than in the top half.
This paper analyses the effect of raising effective marginal tax rates on the income of the representative household in each gross income decile in Australia by one percentage point, and distributing the proceeds of the tax increase either in the form of an equal grant, or as an equal payment to members of households in the lower half of the income distribution. The effectiveness of the program in redistributing income is measured as the ratio of total gains in disposable income to households in target deciles to losses in non‐target groups, or as the proportional reduction in the poverty gap. The cost is measured as the ratio of the sum of the income‐equivalent of changes in the welfare of non‐target groups to those of target groups, or as the ratio of income‐equivalent losses to gains.
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