Efficiency and Equity of a Marginal Tax Reform - Income, Quality, and Price Elasticities for Mexico

The author investigates the effects of a marginal tax reform on household welfare in Mexico. He estimates the extent to which Mexican households react to changes in prices, and uses the estimates to simulate changes in social welfare resulting from marginal tax reform. Results indicate that poorer households tend to have significantly larger income and price elasticities. Hence, to correctly evaluate the effects of economic policies on the poor, it is important to estimate elasticities that reflect the behavioral responses of the poor rather than of the entire population. The results from the micro simulation suggest that since poorer households rely mostly on maize, legumes, and vegetables to fulfill their caloric intake, any price reform that reduces the price of these products will have a larger effect on the welfare of poor households. In particular, reducing the taxes on maize, alcoholic beverages, and vegetables would be both more equitable and more efficient in terms of social welfare. Meanwhile, a reduction in the tax on legumes, sugar, and oils and fats, while inefficient, would contribute to reduce inequality. Finally, a decrease in the price of meat, wheat, and dairy products, while benefiting higher-income households, would have only a marginal impact on poorer households.