Abstract: Over the last decade increasing use has been made of individual household data to analyse the gains and losses from tax reform. Much attention has been paid to the econometric estimation of models of household responses to taxes. But these models yield valid estimates of the welfare consequences of tax changes only when the implied preference orderings are well behaved. This chapter discusses the nature of such conditions in detail. Where there are nonlinearities in the budget constraint, then two sets of primal and dual conditions must be satisfied. The analysis of these conditions yields suggestions for the specification of behavioural models and the use of individual-specific information in the observed data.

Introduction

No subject could be more appropriate or topical for the first World Congress of the Society to be held in the United States than the empirical analysis of tax reform. In May 1985 the president sent his proposals for tax reform to Congress in order “to change our present tax system into a model of fairness, simplicity, efficiency, and compassion, to remove the obstacles to growth and unlock the door to a future of unparalleled innovation and achievement” (U.S. 1985). If enacted, these proposals would make a significant difference to the living standards of many families. The average reduction in taxes as a proportion of income is estimated at 0.6 percent. But only 58.1 percent of families would experience a reduction in taxes (U.S. 1985, Chart 13). It is clear that there are substantial numbers of gainers and losers.