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Working paper

This paper estimates an Inequality Deflator for the Australian economy, which represents the distributional trade-offs that exist within the current tax and transfer system. These trade-offs can be used to evaluate policy alternatives where equity is an important consideration, as well as provide a normative evaluation of the trend towards increased inequality in Australia. This normative evaluation can be justified in two ways. First, it can be argued that the government has revealed a preference for distributional trade-offs through the tax system, which should be followed in other policy analysis. Second, this approach is equivalent to altering the standard Kaldor-Hicks welfare criterion such that compensating payments are made through the existing tax system (rather than as lump sum payments). As such, implementing policy in this way, along with adjustments to the tax and transfer system, can be thought of as identifying realisable pareto improvements. In order to estimate an Inequality Deflator in the Australian setting, this paper develops an estimation method using The Melbourne Institute Tax and Transfer Simulator (MITTS). This methodology also allows for an Inequality Deflator to be estimated at the household level, and for different family types. Finally, the Inequality Deflator is applied to the Australian economy over the period 1994-2013 and finds that if the tax system was used to spread growth equally across the population, growth would be around 18 percent lower than recorded.

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