An Inequality Deflator for Australia

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.