Outline

1. Microsimulation at HM Treasury: methods and challengesDavid Roe and Doug Rendle{david.roe/doug.rendle}@hm-treasury.gov.ukESRC/BSPS UK Microsimulation: Bridging the gapsUniversity of Sussex 11 September 2009

2. Outline • About us • Main interests and methods • Some experiences • Current challenges • Possible future directions

3. About us • Work Incentives and Poverty Analysis team • Budget, Tax and Welfare Directorate • Microsimulation modelling of personal tax, tax credits and benefits • Small unit working across the directorate • Stephen Slater: General distributional analyses including Budget/Pre-Budget Report announcements • Doug Rendle: Income distribution, poverty and work incentives • David Roe: Model building projects

4. Key microsimulation outputs • Analysis of tax-benefit reforms • winners, losers, amounts etc; by family type, household income decile • includes impact of packages of reforms, e.g. in a Budget, or since Government took office • Analysis of the income distribution • impact of reforms on e.g. child poverty • summary measures of household income inequality • Analysis of work incentives and labour supply • distribution of e.g. in/out of work income ratios (incentives to participate) or effective marginal tax rates (incentives to progress) • labour supply responses to reforms

5. Methods: tax-benefit modelling • Intra Government Tax Benefit Model (IGOTM) • users in HM Treasury, HM Revenue & Customs, Office for National Statistics, Communities and Local Government, Scottish Executive • Classic household tax-benefit microsimulation model • see also PSM, TAXBEN, EUROMOD etc. • Partial benefit coverage • e.g. disability/incapacity benefits are reported not modelled • Input data • Expenditure & Food Survey or Family Resources Survey • Static ‘no behaviour’ model • labour supply and consumption decisions fixed

6. Methods: labour supply modelling • ‘Employment transitions’ model • Myck, M. & Reed, H. (2005), “A Dynamic Model of Labour Market Transitions and Work Incentives”, available at www.ifs.org.uk • labour market entry/exit conditional on in/out of work incomes and personal/family characteristics • matching of data from Labour Force Survey (for transitions) and Family Resources Survey (for modelled incentives) • participation effects only, likely in work wage/hours fixed • no ‘feedback’ from changed behaviour to household incomes • New model of hours worked under development

7. Experience: model maintenance • Challenge of developing and maintaining ‘complex’ models: • detailed tax-benefit rules and maintenance • estimation of behavioural models • 5-year period with ‘out-of-house’ model maintenance and development • Some points to watch: • became less critical model users • ‘ready-to-use’ tools not always sufficiently flexible

8. Case study: financial support for children • Background • 2000: First in series of explicit Government target to reduce relative child poverty rates • April 2003: tax credits reformed into single source of means-tested support for children • Microsimulation contribution • costs, impacts, and ranking of range of possible reforms to financial support • trade-offs with work incentives • uncertainty in modelling outcomes • Issues • strict focus on ‘changes’ • assumptions, e.g. take-up

9. Case study: personal tax reforms • Background • Budget 2007 ‘personal tax package’: changes to income tax rates, aged allowances, NICs thresholds, and tax credit thresholds, rates and taper • Microsimulation contribution • highlighting complex patterns of distributional gains and losses • compensating the losers • e.g. see Treasury Committee, Budget Measures and Low-Income Households, 28 June • Issues • e.g. household, family or adult level analysis?

10. Current challenges: IGOTM • IGOTM review 2009 • audit against 2009-10 rules • coverage of benefits • code rationalisation • model documentation • Progress • from scratch rewrite of income tax, indirect tax and IS/JSA etc. modules • rationalisation and documentation of most remaining modules • need review of measurement framework against DWP Households Below Average Income (HBAI)

11. Current challenges: poverty analysis • Background • Government legislating commitment for ‘eradication’ of child poverty by 2020 • Issues • consistency with key poverty source: HBAI • horizon too long to base policy analysis on current population • more ‘scenario’ modelling • improved flexibility, e.g. on take-up assumptions

12. Current challenges: labour supply • New labour supply model • under development with Alan Duncan (Nottingham University) • structural discrete model of hours worked • observable + unobservable variation in leisure/income preferences • probabilistic simulation • Some issues • assumptions, e.g. rational choices with perfect information • estimation, e.g. functional form, choice states, fixed costs • simulation, e.g. runtime

13. Possible future directions • Longer-term modelling • e.g. rise in women’s state pension age • Distributional ‘forecasting’ • e.g. winners/losers as growth, jobs, prices, interest rates evolve • Behaviourally-adjusted microsimulation outputs • e.g. ‘in-work’ poverty • Intra household allocations • e.g. which individuals really win/lose? • Typically active research areas in academic/wider community and/or techniques well established