How incentives matter? An illustration from the targeted subsidies reform in Iran

Abstract

We use the targeted subsidies reform implemented in Iran in 2011 to recover empirically the social valuations of Iranian households relying on the assumption of optimal consumption and income taxes, for welfarist and non-welfarist poverty alleviation social criteria. Unlike the existing literature, we do not restrict attention to a specific pattern for the incentive constraints implied by nonlinear income taxation. Instead we recover this pattern by estimating the Lagrange multipliers associated with the incentive constraints. Before the reform we find evidence of redistribution toward the bottom poor income deciles that is limited by an incentive constraint where the rich envy the social treatment of the poor. At the outcome of the reform incentives no longer matter and the social welfare function of the government of Iran displays a Benthamite-like form.