Indirect Tax Reform and the Specification of Demand: the Case of Ireland

This paper examines the sensitivity of marginal tax reform analysis to changes in the underlying demand system. In particular, we analyse the sensitivity of results from Ahmad and Stern's (J Publ Econ 25(3):259-298, 1984) marginal tax reform model to different specifications of Deaton and Muellbauer's (Am Econ Rev 70(3):312-326, 1980) Almost Ideal Demand System (AIDS) and Banks et al.'s (Rev Econ Stat 79(4):527-539, 1997) Quadratic AIDS. Using Irish Household Budget Survey data, we show that tax reform results exhibit a low degree of sensitivity to changes in the underlying demand system. An adjustment for a mass of observed zero-expenditures in the data for certain goods produces most sensitivity in the tax reform results. Even in these cases, many of the tax reform recommendations remain constant. Including demerit good arguments in the tax reform model can substantially alter the tax reform recommendations relating to demerit goods. Notably though, when we include these arguments in the tax reform model, the results are particularly insensitive to changes in the underlying demand system.