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A decade of personal tax and transfer reforms in the UK: in search of equity or efficiency?

A decade of personal tax and transfer reforms in the UK: in search of equity or efficiency?. Mike Brewer Institute for Fiscal Studies, UK. Overview. 1. What has the UK government done 2. Impact on distribution of income and relative poverty 3. Impact on measures of work incentives

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A decade of personal tax and transfer reforms in the UK: in search of equity or efficiency?

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  1. A decade of personal tax and transfer reforms in the UK: in search of equity or efficiency? Mike Brewer Institute for Fiscal Studies, UK

  2. Overview 1. What has the UK government done 2. Impact on distribution of income and relative poverty 3. Impact on measures of work incentives 4. Current topics

  3. What is the IFS? • IFS is independent, politically-neutral, (mostly) micro-economics research institute • Very high media profile in fiscal policy and tax and transfer design • Funded by research councils, charitable trusts, EC, contracts with UK government, members • My background: • Civil service (HM Treasury, 1997-2000) & IFS (2000 – )

  4. 1. What has the UK government done since 1997? • Personal tax and transfer reform • Income tax schedule from 20/24/40% to 20/40%; fiscal drag means more taxpayers & a lot more higher-rate taxpayers • Small in-work cash benefit expanded and transformed into child and working tax credits • National insurance: kinks and cliff-edges removed; gradual alignment with IT • Welfare payments: huge rise in generosity only for families with children, mirrored in child tax credit for those in work • Housing benefit (means-tested programme providing rent assistance) made less aggressively means-tested • Minimum wage introduced • Welfare reform (active labour market policies, conditionality, rights and responsibilities) [not covered] • Lone parents: little change until 2008 • Sick and disabled (incapacity benefit): little change until 2008 • The rest: substantial change from 1997; now much tougher regime • Comprehensive reform of cash payments to pensioners [not covered] • No indirect, housing or local tax changes

  5. 1. What has the UK government done since 1997? • Personal tax and transfer reform • Phase 1: tax reforms to strengthen incentive to work & reduce very high METRs • Minimum wage • Removing kinks and cliff-edges in NI • Reform in-work cash benefit (FC to WFTC) to promote work (for primary earners) in families with children • Phase 2: tackle child poverty through broad-brush redistribution; make Revenue department (HMRC) responsible for cash handouts • Increase welfare payments for children and mirror in in-work benefits to hit tough child poverty target • Combine all cash support for children into 2 programmes (child benefit and child tax credit) • Phase 3: new methods for old goals • Still focus on child poverty • Welfare reform for lone parents: justifies higher support for welfare recipients? • HB reform to strengthen gain to work • Time-limited (and targeted) in-work bonuses despite evidence on long-run efficacy

  6. 2. Impact of tax and transfer changes, 1997-2007 Source: Phillips (2008) Notes: Changes measured relative to usual uprating rules. Includes net rise in taxes which do not directly affect households whose impact is assumed proportional to income (worth 2.5% of income).

  7. 2. Relative poverty fallen for households with children, but not those without Source: official data plus authors calculations based on FES/FRS. Summary statistics available from http://www.ifs.org.uk/bns/bn19figs.zip

  8. 3. Work incentives • High METRs over time (HM Treasury) • METRs and PTRs of different family types (now) • A critique of the UK tax and transfer system on efficiency grounds

  9. The changing distribution of high marginal effective tax rates Source: chapter 4 of various budget documents produced by HM Treasury (http://www.hm-treasury.gov.uk/budget/budget_08/bud_bud08_index.cfm). METRs measured for head of family only, and only if head works 16+ hours/week.

  10. Work incentives for single-adult families, 2008/9 (simulated) Source: from Brewer et al (2008) and based on analysis of FRS using TAXBEN. Notes: PTR = participation tax rate = 1 – (inwork_income – outofwork_income)/gross_earnings. Includes employers NI but not consumption taxes.

  11. Work incentives for single-adult families , 2008/9 (simulated) Source: from Brewer et al (2008) and based on analysis of FRS using TAXBEN. METR = marginal effective tax rate. Includes employers NI but not consumption taxes.

  12. Work incentives for second-earners in couples families , 2008/9 (simulated) Source: from Brewer et al (2008) and based on analysis of FRS using TAXBEN. Notes: PTR = participation tax rate = 1 – (inwork_income – outofwork_income)/gross_earnings. Includes employers NI but not consumption taxes.

  13. Work incentives for second-earners in couples families , 2008/9 (simulated) Source: from Brewer et al (2008) and based on analysis of FRS using TAXBEN. METR = marginal effective tax rate. Includes employers NI but not consumption taxes.

  14. Critique of UK system on efficiency grounds • Brewer, Saez and Shephard (2008) conclude: • Participation tax rates are very high for very low earners • METR is very high (70+%) for those on low to middle earnings and receiving tax credits • Housing benefit has an extremely aggressive means-test and a very low take-up rate amongst workers • Income transfer programmes and tax credits for working families need more simplicity and certainty • Therefore: • More earnings disregards for primary earners in welfare benefits, and for second earners in tax credits • Increase value of working tax credit • Lower taper in tax credits • All reduce tax revenues, and no scope for increasing tax rate on richest • None helps poorest, although Brewer et al were considering efficiency, not equity

  15. 4. Current topic A: operation of tax credits • Govt wanted tax credits to reflect current annual income and current family circumstances • But HMRC does not know either of these, so: • Use last year’s income or estimate of current year income • Families have to report changes in family circumstances to HMRC ASAP • Childcare subsidy: families have to report changes in weekly spend on childcare in real-time • Result: • Lots (initially 1 in 3 awards) of “over-payments” • Very hard to predict entitlement, so accurate “better off” calculations not possible • Huge burden for welfare rights/advocacy groups • Considering introducing systematic under-payments to reduce over-payments

  16. 4. Current topic B: abolition of the 10% starting rate (or “how not to do a personal tax reform”) • 1997: income tax: 20/24/40% • 2007: income tax: 10/22/40% • 2008: income tax: 20/40% • “To pay for a cut in the basic rate of income tax in his final budget as chancellor last spring, Mr Brown removed the 10p ($0.20) starting rate.” The Economist 24/4/08 [NB spot the sub-editor’s mistake!] • Despite spending £2.4bn/yr on offsetting measures for adults aged 65+ and tax credits recipients, 1 in 5 low-paid working-age households without children worse off • Mini-budget of May 2008 announced £2.7bn/yr rise in personal allowance • Still 1m households losing, but very small amounts • Government still criticised for simplifying tax reform costing it over £5.1bn/yr because <£0.1bn/yr being raised from low-earners.

  17. Conclusions: equity or efficiency? • Families with children • UK government has been redistributing substantially to families with children • Initially this was pro-work and pro-poor, but recently just pro-poor • New emphasis on different ways of encouraging work (welfare reform, time-limited incentives) • 2010 target on child poverty likely to be missed • Families without children • Much fewer changes so little impact on incomes or work incentives; relative poverty and inequality rising

  18. End

  19. Key (IFS) references • Adam et al (forthcoming), Taxation in the UK, submission to Mirrlees review of the UK tax system, http://www.ifs.org.uk/mirrleesreview/publications.php • Adam et al (2006), Financial work incentives in Britain: comparisons over time and between family types, IFS WP 06/20, doi: 10.1920/wp.ifs.2006.0620 • Brewer (2007), Welfare reform in the UK: 1997 – 2007, IFS WP 07/20, doi: 10.1920/wp.ifs.2007.0720 • Brewer, Shephard and Saez (2008), “Means-testing and tax rates on earnings”, submission to Mirrlees review of the UK tax system, http://www.ifs.org.uk/mirrleesreview/press_docs/rates.pdf • Phillips (2008) chapter in IFS Green Budget 2008, http://www.ifs.org.uk/budgets/gb2008/gb2008.pdf • Survey of the UK tax system, http://www.ifs.org.uk/bns/bn09.pdf • Survey of the UK benefit system, http://www.ifs.org.uk/bns/bn13.pdf

  20. Extra slides

  21. Spare: impact of changes to taxes and transfers, 1997 - 2007 Source: Phillips (2008) Notes: Changes measured relative to usual uprating rules. Includes net rise in taxes which do not directly affect households whose impact is assumed proportional to income (worth 2.5% of income).

  22. Budget constraints for lone parent (change in WFTC only) Assumes 2 children < 11, hourly wage of £5/hour, no childcare costs, no rent, no child support

  23. Budget constraints for lone parent Assumes 2 children < 11, hourly wage of £5/hour, no childcare costs, no rent, no child support

  24. Budget constraints for a 2nd earner in a couple with children Assumes 2 children < 11, hourly wage of £5/hour, no childcare costs, no rent, no child support, partner earns £300/wk

  25. Incentives to progress for a lone parent Assumes 2 children < 11, hourly wage of £5/hour, no childcare costs, no rent, no child support

  26. Incentives to progress for lone parent for 2nd earner in a couple with children Assumes 2 children < 11, hourly wage of £5/hour, no childcare costs, no rent, no child support, partner earns £300/wk

  27. Changes in replacement rates from UK reforms 1997-2004

  28. Changes in effective marginal tax rates from UK reforms 1997-2004

  29. Changes in marginal tax rates from UK reforms 1997-2004 : lone parents

  30. Change in marginal tax rates from UK reforms 1997-2004: working parents in one-earner couples

  31. Change in marginal tax rates from UK reforms 1997-2004: working parents in two-earner couples

  32. Comparing 1997 to 2004: • The incentive to work at all is • stronger for most lone parents • for individuals in couples, more likely to be weaker than stronger • Couples with children face larger incentive to have 1 worker and 1 carer • 225,000 fewer working parents face effective marginal tax rates over 80%, but 900,000 more face rates over 50% • Effective marginal tax rates have fallen for low-earning lone parents, but risen at higher earnings • Effective marginal tax rates have risen for over 40% of parents in couples • Very detailed impression of impact on FWI

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