Accounting for Labor Supply Behavior in Tax-Benefit Simulations: An Evaluation of the Luxembourg REVIS Reform

This project evaluates the labor supply and distributional effects of the 2018 reform of the Luxembourg minimum income scheme, which replaced the Guaranteed Minimum Income (RMG) with the Social Inclusion Income (REVIS). The reform was motivated by growing concerns about inactivity traps, weak coherence between income support and activation policies, rising poverty risks among children and single-parent families, and excessive administrative complexity. REVIS aims to promote social inclusion, strengthen work incentives, improve child and single-parent poverty outcomes, and simplify administration. A key innovation of the reform is the introduction of a direct income immunization mechanism, whereby 25 per cent of household income is disregarded when calculating benefit entitlements. This represents a paradigm shift away from the pre-reform system, which effectively imposed very high implicit marginal tax rates on low earnings.

To assess the effects of this reform, the project combines detailed tax–benefit microsimulation with a microeconometric Random Utility Random Opportunity (RURO) labor supply model, using Luxembourg Income Study (LIS) data. Standard “arithmetical” microsimulation models are well suited to analyzing first-round, non-behavioral effects of tax–benefit reforms, such as changes in disposable income, poverty, inequality, and public budgets. However, they may be misleading when reforms are non-marginal or when medium- to long-run impacts are considered, as individuals may adjust their labor supply by changing employment status, hours of work, or job characteristics. Incorporating behavioral responses is therefore essential for evaluating reforms like REVIS, which explicitly aim to alter w

The RURO approach departs from traditional labor supply models in which individuals choose hours of work from a continuous set assumed to be equally available. Instead, individuals are modeled as choosing among discrete job opportunities characterized by different packages of hours, wages, and so on

Empirically, the project proceeds in several steps. First, various versions of the RURO model are estimated and validated using LIS data for Luxembourg, with particular attention to labor market exclusion and heterogeneity in opportunities between “insiders” and “outsiders.” Single mothers are a focal group, given the reforms explicit concern with child and single-parent poverty and their sensitivity to work incentives. Second, the RURO model is integrated into the LuxTaxBen microsimulation framework, a policy tool designed for ex ante analysis of Luxembourgs tax–benefit system. LuxTaxBen provides detailed simulations of disposable income and benefit eligibility under alternative policy scenarios and is adapted here by replacing its standard labor supply module with the RURO model.

Finally, the integrated model is used to evaluate the effects of REVIS relative to RMG. The reform replaces the near-100 per cent implicit marginal tax rates of the pre-reform scheme with a structure closer to a negative income tax, allowing guaranteed income to increase with earnings and thereby strengthening incentives to work. The analysis compares simulated and observed labor supply outcomes under pre- and post-reform regimes, using both forward and inverse simulation strategies. This dual approach allows not only an assessment of the reforms impacts on labor supply, poverty, and public finances, but also a validation of the modeling framework and deeper insight into the mechanisms.