Tax credits: time to stop weakening work incentives?

1. Tax credits: time to stop weakening work incentives? Mike Brewer, Institute for Fiscal Studies

2. Outline • Recent tax credits changes are weakening incentives to work • Can we reduce child poverty without weakening work incentives?

3. Background • Transfers to poor (ie not paid to rich) weaken work incentives • Out-of-work income rises, in-work income rises less • EMTRs rise because transfer withdrawn as income rises EMTR = effective marginal tax rate = how much of a small change in income is lost to extra tax and reduced transfers

4. Recent tax changes and parents’ incentive to work • Between 1999-2003 • Increased % of lone parents in work • Slightly reduced % of women in couples in work • Since 2003 • Incentive to work all & incentive to progress weaker now that in 2003, particularly for those in couples with children • Set to continue until (at least) 2007

5. Four anti-poverty policies for tax credits • Increase per child element of child tax credit • Helps poor, but weakens work incentives • Increase working tax credit • No direct help for poorest. Strengthens incentive to work in workless families, weakens it for 2nd earners. Weakens incentives to progress for all • Introduce “3rd child premium” • Good indicator for being poor. Minimal impact on WI. Fertility? • Extend baby tax credit to under 5s • Redistributes across lifecycle rather than between families. Minimal impact on WI.

6. Distributional impact Note: poverty line somewhere in 3rd decile

7. Distributional impactrelative to CTC

8. Impact on incentive to work at all (replacement rate)

9. Impact on incentive to progress (METR)

10. Conclusions • No single measure can affordably cut poverty without harming work incentives • Post-2003 tax credit changes are undoing the “good work” of previous tax and benefit reforms • Can redistribute to families in poverty without a means-test • Maybe time to increase WTC rather than CTC?

11. The end