WP 2 – Counterfactual scenarios

A wide range of factors have influenced the income distribution since the commencement of the Lisbon strategy. Many of these (such as demographic change or the distribution of work across households) have not been under direct control of policymakers or amenable to public policy intervention. In assessing the performance of government policy in terms of (income) poverty reduction it is therefore important to isolate the impact of the most relevant factors that policy makers are able to control. These are the structure and generosity of the system of cash income protection and the direct tax allowances and reliefs.

The question we address in this work package is whether policy reforms in the past decade contributed to the disappointing poverty outcomes or alternatively helped to reduce the risk. We engage in counterfactual scenarios using EUROMOD for a selection of 6 to 8 countries and investigate what the income distributions would have looked like if policy reforms had not taken place. We will compare what the outcomes of the 2001 policies would have looked like if they had been retained until 2011 – with no policy reforms – with the outcomes of the actual 2011 policies. The implications for the poverty threshold and for income poverty indicators will be drawn out.

Furthermore, the analysis will highlight the role of regular uprating of benefits and tax thresholds (for instance automatic adjustments or indexation) in maintaining the level of pensions and welfare benefits relative to the median income and in maintaining the tax ratio across the income distribution. In a period of real earnings growth, low incomes will tend to drift below the poverty threshold as it rises in real terms, unless benefits are indexed by more than inflation. Extra interventions will be needed to keep these people above the poverty thresholds as these initiatives may be hailed as designed to reduce poverty rather than to simply help low incomes keep pace. While it might be expected that the intervention would result in a reduction in poverty, in fact the result may have been a “disappointing” constant or rising poverty rate. But without the policy intervention the outcome might have been even worse. Similarly, if policies are not indexed at all on a regular basis, frequent policy interventions are necessary just to keep pace with real incomes. They too may have a disappointing impact on poverty.

The extent to which policies have fallen behind (and, by implication, public budgets diverted elsewhere) will be documented. “What would have happened anyway” will be modelled, using a number of alternative assumptions, and will provide a baseline against which to assess the 2011 poverty indicators.