in 2015. Other spending categories (defense, public order and safety) and are likely to be less relevant from a distributional impact perspective.

# **_Empirical Strategy_**

The empirical strategy is described below, including the assumptions made for the allocation methods used to match household-level data with fiscal and program information, and to work around the challenges encountered given the microdata at hand.

## **Direct taxes**

The application of the method to Albania includes **personal income taxation** and **social security contributions** . It assigns the statutory rates for wage and self-employed to those formally employed (informality assumption explained below) by grossing up labor income. It assumes that the burden of taxes paid by the employer falls fully on the employees.<sup>16</sup> The application of the methodology to Albania makes assumptions of **labor market informality** , which implies non-payment of personal income tax or social security contribution. Those assumed to be formal in the labor market and contributing to PIT and SSC are private sector employees with a permanent job or indefinite time contract, or temporary job with short term contract; or employees of the public sector or international organizations. The informal workers include the private sector employees in temporary jobs without a contract, occasional or seasonal job, and unpaid workers. The informality rate derived from this assumption (among the employed 15-65) is 33 percent in 2015, which is comparable to 31.4 percent in the 2015 Labor Force Survey.<sup>17</sup> Two important challenges were present in identifying individual labor income. The first challenge was the identification of the portion of household disposable income (in this case equivalent to total household consumption) that was attributable to labor market income. Given that labor income data in the survey was assessed to be largely underreported, some steps were taken and assumptions made to identify labor income: (i) direct transfers and market income from other sources, as reported in the survey, were subtracted from total consumption; (ii) the residual, labor income, was scaled-down at the household-level and for all households. The adjustments were made across the board, using as a scale down factor the matching of formal-sector wages in the survey with the corresponding wages in administrative data.

The second challenge relates to assigning the total labor income identified to employed members earning income within the household (thus excluding unpaid family workers), given the lack of individual-level wage or earnings data for each household. This is important in Albania given the progressivity in personal income taxes. Data showed that a large share of households with earners had only one employed household member (57 percent), in which case all labor income (from wage or self-employment) was assigned to that person. If more than two household members worked (35 percent) and were wage employed, labor income was assigned using ratios for main and second earner estimated from the Labor Force Survey 2013, conditioning on educational levels.<sup>18</sup> If two or more people in the household were self-employed (with only

> 16 As in Lustig and Higgins (2017).

> 17 Informality here is expressed as the share of informal work relative to non-agricultural employment. Source: INSTAT, official estimates.

> 18 We need to allocate labor income across household members conditioning on education. To do that, we run Mincerian regressions using wage data in the LFS to estimate the ratio of main to second earners. These regressions were run separately for the following

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