Chapter 5: Decomposing Changes in Income Distribution

For at least two decades, the potential and usefulness of microsimulation models for researching tax-benefit systems had found widespread acceptance. National models have been extensively used to evaluate the effect of current or past reforms on inequality or poverty. Tax-benefit microsimulation has also been used to predict alternative or hypothetical systems, including announced scenarios of potential reforms, to help policy makers in the design of reform or to allow international comparison of redistributive systems. More recently, it has been suggested to formally decompose the change in inequality and poverty over time in order to extract and quantify the actual contribution of tax-benefit policy reforms. This method relies on tax-benefit microsimulation to construct counterfactual distributions used to identify the relative effect of policy changes. This is an important, retrospective use of tax-benefit microsimulation for analysts and policy makers as it helps to understand whether actual tax-benefit reforms have achieved their objectives in terms of redistribution. The present chapter reviews the context, the decomposition approach, recent development and future research paths regarding this branch of the microsimulation literature.