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A Cost-Benefit Analysis of Cash Transfers Within A General Equilibrium Framework : Simulations Based On Mexico ' s PROGRESA Cash Transfers

This paper combines computable general equilibrium modeling with disaggregated household data to evaluate the general equilibrium welfare impacts of cash transfer programs arising from the need to finance these transfers domestically. We separate the indirect welfare impact into three components: (i) the redistribution effect arising from the need to finance programs, (ii) the reallocative effect arising from the transfer of resources between households with different "tax propensities", and (iii) the distortionary effect arising from the need to use distortionary finance instruments. We show how all these effects can be subsumed within one parameter, namely, the cost of public funds. Using the Mexican cash transfer program as a basis for simulations, we show that the substantial welfare gains which result from the switch from universal food subsidies to targeted cash transfers reflect both the improved targeting efficiency of the latter as well as relaxing the need to trade-off equity objectives against efficiency when designing tax systems. More generally, the indirect costs of finance can be substantially lowered when such programs are combined with appropriate tax reforms.