Income include different elements of publicly provided transfers (or publicly mandated revenue collections). Consequently, each is a post-fiscal income concept. Once the team has made the allocations, it calculates measures of poverty and inequality.

# <u><mark>Box 1: CEQ Terminology and Application in Zambia</mark></u>

Taxes and transfers, and fiscal policy more generally, are powerful instruments at the disposal of the state for reducing extreme forms of material deprivation and narrowing the gap between economic elites and the rest. They can also help to equalize opportunities, through public education for example, and thus increase social mobility and the productive potential of the underprivileged. To assess whether governments are using these tools effectively, it is important to be able to quantify how inequality and poverty change before and after the application of these fiscal policies.

To quantify the impact that fiscal policies have on income (or purchasing power, or welfare), the team first must estimate a (counterfactual) income state that would be experienced **_before_** the transfers, benefits, and burdens generated by the fiscal system are received or imposed. As a proxy for this state, the team defines **_pre-fiscal income_** Ih as the cumulative income received from wages and salaries (that is, from labor market transactions) plus the market value of auto-production and auto-consumption; from capital (including real estate); and from private transfers (such as remittances from family members working abroad). The _h_ subscript indexes a set of households (but equally could index individuals).

The team then assembles a set of taxes and transfers Ti that it wants to examine: for example, Ti in Zambia might include the Pay-as-You-Earn (PAYE) personal income tax and the Farmer Input Support Program (FISP). For each household _h_ , the team then uses the micro-data (for Zambia, the Living Conditions Monitoring Survey or LCMS), to allocate **_shares_** ( _Sih_ ) of each program i= 1,....I in Ti to each household _h_ .

With the estimated shares, the team generates **_post-fiscal income_** at the household level Yh such that: _Yh_ = _Ih -_ Σ _i_ Ti _Sih._ (1) Figure 5 provides a schematic of the equation above. Figure 5 contains only one pre-fiscal income concept (Market Income) and several post-fiscal income concepts (Disposable Income, Consumable Income, Final Income).

To determine the **_impact of the fiscal system_** on either poverty or inequality, the team takes the difference between its preferred measures of poverty or inequality over the pre- and post-fiscal distributions. Naturally, the extent of the fiscal system under consideration limits the team’s choice of the post-fiscal income concept. The impact of a fiscal system that includes only two elements must be estimated over a post-fiscal income concept that includes only these two elements.

To determine the **_impact of single tax or transfer_** (or a subset of taxes and transfers), the team takes the difference in inequality (or poverty) at the post-fiscal income concept **_excluding_** the item in question (but including everything else in the team’s fiscal system) and the post-fiscal income concept **_including_** the item in question (and also including everything else in the team’s fiscal system).

A single tax or transfer (or a fiscal system) is **_inequality reducing_** when the addition of the fiscal item in question to an income concept reduces measured inequality. A transfer is **_absolutely progressive_** if, when households are ranked by pre-fiscal income levels, the cumulative household shares of the transfer are greater than cumulative population shares. In a Lorenz curve figure, an absolutely progressive transfer’s concentration curve would lie above and to the left of the 45 degree line. A transfer (tax) is **_relatively progressive_** if, when households are ranked by pre-fiscal income levels, the cumulative household shares of the transfer (tax) are greater (less) than the cumulative household shares of pre-fiscal income. In a Lorenz curve figure, a relatively progressive transfer’s (tax’s) concentration curve would lie above and to the left (below and to the right) of the Lorenz curve for pre-fiscal income.

The team calls a transfer **_pro-poor_** when the transfers received, measured as a share or fraction of pre-transfer income, decline with income. Notice that this definition of pro-poor includes cases in which the absolute transfer level declines with income. For example, if a transfer is targeted to poor households, and non-poor households do not receive the transfer, then, <u>algebraically, transfers received are declining in income level. Because taxes always reduce purchasing</u> 15