A consistent assessment of social welfare by two methodologies. The theory and evidence from the Luxembourg Income Study database

Research background. Applied welfare economics offers various social welfare functions (SWF) for appraising income distributions. Social planners commonly use two SWFs: SWFε implied by income inequality aversion (ε) and SWFv implied by rank inequality aversion (v). However, a voluntary choice of ε or v may result in inconsistent assessments of social welfare embodied in a given income distribution. Purpose of the article. We search for the combinations of ε and v that guarantee consistent assessments of social welfare, inequality and poverty embodied in a given income distribution. Methods. We propose estimating the pairs (ε,v) by solving the system of two nonlinear equations. The first equation comprises the equally distributed equivalent incomes derived from SWFε and SWFv. The second equation comprises the benchmark incomes. A small increase in income below the benchmark income reduces inequality, whereas a small increase above the benchmark income increases inequality. The system of these equations can be solved numerically. Findings and Value added. We have estimated ε, v, and related characteristics for selected Latin America and Caribbean countries using Luxembourg Income study database data.