The understanding of the distributional dynamics has been for long at a center stage in the economic debate. This project will contribute to the renewed involvement of the scientific community in this issue, combining three main branches of the literature: the pro-poor growth literature, the tax evasion literature, the markets dynamics literature.
The first part of the project aims at developing a framework to evaluate the social welfare implications of growth generated by a profile of income streams. Differently from existing contributions, the complete and partial dominance conditions that will be developed will be sensitive to the economic status of individuals and to all the possible changes of a distribution that take place within the overall growth process. The second part of the project aims at providing synthetic measures of pro-poorness. Differently from existing contributions focusing on the impact of growth on transient poverty, our measure will allow to capture the effect of growth on the dynamics of the poor individuals, by considering both the direct effect of growth and the indirect effect of mobility on the distribution. The third part of the project aims at understanding the role of tax evasion in shaping individuals' income streams. Differently from previous contributions focused on cross-sectional and aggregated evaluation of the distributional impact of tax evasion, our framework will allow accounting for this impact in each single part of the distribution and will endorse a dynamic perspective. The fourth part of this project aims at connecting the above-described transmission mechanisms to the dynamics observed in financial markets. We aim at understanding the effect of which distortions, such as those arising from inequality and tax regimes, affect asset prices. We aim at studying methods that allows correcting the way in which equilibrium models of the economy price financial assets using the notion of stochastic discount factor.
Concerning the first part of the project, most of the literature that discusses the evaluation of the distribution of income streams uses a two-period framework. We propose to evaluate individuals' welfares defined over any number of periods. Chakravarty et al. (1985) proposed a related approach. Differently from their contribution, we will generate a hypothetical time path of incomes by replacing their assumption of relative immobility by an assumption of absolute immobility. Our social welfare function will not depend on individuals' time averaged incomes, but on their time invariant equivalent incomes. Hence, we will take into account aversion with respect to fluctuations in incomes. Our proposal will also differ from the recent contributions by Aaberge and Mogstad (2010). They propose a two-step procedure where the immobile situation is a situation in which individuals' ranks do not change over time and define mobility as the decrease in inequality in the distribution of time invariant equivalent income, due to changes over time in individuals' ranks and income shares in the short-term distributions of income. We will measure mobility by the contribution of rerankings to the welfare gain compared to the absolutely immobile first period distribution. Furthermore, we will develop additive decompositions to capture all the possible effects of growth on individual and social welfare.
Concerning the second part of the project, a common feature of the existing tools that investigate the dynamic relationship between growth and poverty is that the identity of the income recipients is irrelevant (Ravallion and Chen 2003; Son 2004; Duclos 2009). This implies accounting for the variation of the transitory component of poverty, while ignoring its intertemporal features: two normatively different aspects of poverty. Hence, the first innovative aspect is that we will evaluate pro-poorness by looking at each individual poverty trajectory over time. We will base our analysis on a measure of intertemporal poverty. Whereas existing measures are based on indexes of transient poverty. The second innovation is the formal recognition of the role played by mobility in the growth pro-poorness evaluation, usually neglected in existing works.
Regarding the third part of the project, the distributional impact of tax evasion is assessed using methods based on the comparison of incomes at a series of common points in the income Parades between, for instance, the distribution generated by full compliance and the distribution generated by tax evasion. However, looking at the change in the income of the person at a specific quantile of Parade A and the person at the same quantile of Parade B ignores the fact that the persons concerned are not the same individuals. These methods do not necessarily tell us how individual households are faring. Every income group might change its composition because of tax evasion. To assess whether the individuals who are poor (or rich) are gainers or losers, one has to track the fortunes of individuals not the fortunes of income groups. Our methodology will differ from existing contributions in this respect, as it will account for the reranking of individuals. Moreover, we will investigate on the impact of tax evasion on the distribution by introducing a dynamic perspective, in order to verify which specific aspect of growth is affected most by tax evasion and why, analyzing the impact of tax marginal rates on the specific income classes. We will use RIF regression techniques that have never been used in the context of tax evasion and its distributional implications. A key advantage of such an approach over conventional inequality decomposition methods is that RIF regressions allow us to assess the distributive impact of a notional marginal increase in one of the components of growth both unconditionally and conditionally on other relevant covariates.
Last, we will propose a new methodology to correct completely the price predictions generated by a given model, so that its implications can be judged reliable from a normative perspective. Differently from existing contributions, our methodology will be able to correct the pricing properties, and their welfare implications, of a general/partial equilibrium model of a representative agent. We will do it by adopting the APT framework of Ross (1976) that will allow merging two branches of the literature, one focused on studying the extent to which an asset-pricing model respects the stochastic discount factor bound, the other on the assessment of whether a given equilibrium model provides accurate predictions with respect to the unobserved true model.
The outcome of this project will arise to be relevant not only for the scientific community but also for policy makers. It will help to find out who are the winners and losers from growth and/or from tax evasion, a useful information, for example, in the evaluation of the efficacy of policy reforms.