Semi-parametric estimation of the EASI model: Welfare implications of taxes identifying clusters due to unobserved preference heterogeneity

Abstract

We provide a novel inferential framework to estimate the exact affine Stone index (EASI) model, and analyze welfare implications due to price changes caused by taxes. Our inferential framework is based on a non-parametric specification of the stochastic errors in the EASI incomplete demand system using Dirichlet processes. Our proposal enables to identify consumer clusters due to unobserved preference heterogeneity taking into account, censoring, simultaneous endogeneity and non-linearities. We perform an application based on a tax on electricity consumption in the Colombian economy. Our results suggest that there are four clusters due to unobserved preference heterogeneity; although 95% of our sample belongs to one cluster. This suggests that observable variables describe preferences in a good way under the EASI model in our application. We find that utilities seem to be inelastic normal goods with non-linear Engel curves. Joint predictive distributions indicate that electricity tax generates substitution effects between electricity and other non-utility goods. These distributions as well as Slutsky matrices suggest good model assessment. We find that there is a 95% probability that the equivalent variation as percentage of income of the representative household is between 0.60% to 1.49% given an approximately 1% electricity tariff increase. However, there are heterogeneous effects with higher socioeconomic strata facing more welfare losses on average. This highlights the potential remarkable welfare implications due taxation on inelastic services.