Should We Like it? - A Social Welfare Based Quantification of Policy Attractiveness

Inequality has again become prominent in public and scientific discussion. There is a vast literature on its measurement, and numerous empirical papers describe and compare the situation in different countries. However, these results can barely be used to evaluate (potential) policy decisions that change the underlying state variables such as income or wealth. A classic approach for such evaluation uses social welfare functions, but the research in this field often only provides conceptional procedures which are not appropriate for empirical comparative studies. In this paper, we propose a new tool that measures the attractiveness of a policy decision, based on a social welfare function. The so-called substantial welfare ratio, is motivated by the literature on performance measurement and incorporates an inherent robustness check. In particular, it investigates the impact of small modifications at the tails of the change distribution. Additionally, it meets several criteria for good inequality and performance measures, making decisions based on the ratio consistent with those based on such measures. We provide an application to European data, for which we adopt a stylized life-cycle model, in order to motivate the shape of the underlying welfare function. The example shows that the new tool can be used to analyse policy decisions such as tax-reforms and thereby reveals differences in the attractiveness and welfare structure.