The efficiency and effectiveness of income transfer systems : a comparative study using microdata

Abstract

This study uses the microdata assembled by the Luxembourg Income Study (LIS) to examine the impact of the social security and taxation systems on poverty and inequality in ten OECD countries, circa 1980. A model of income transfer processes is developed to show the relationship between government expenditure, transfer instruments and the outcomes of the transfer process. The study adapts and extends existing methodologies in the poverty and inequality literature. These measures are then applied to the LIS microdata to reveal the efficiency and effectiveness of both the social security and taxation systems in the countries chosen for comparison. The analysis shows that, in general, it is the larger welfare states which are the most effective in reducing poverty and inequality. The most efficient welfare states are those which apply either income tests to direct transfers and/or have highly progressive taxation systems. There appears to be a trade-off between the efficiency and effectiveness goals of the transfer systems in the LIS countries. The findings of the empirical analysis are contrasted with several streams of the welfare state literature to examine the degree of correspondence between theory and 'real-world' outcomes. The study shows that many of the conventional wisdoms of the welfare state literature do not hold empirically. This is attributed to the lack of attention to the role of taxation, expenditure efficiency and the incidence of transfers among the pre-transfer poor population.