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Work incentives and income redistribution

Work incentives and income redistribution. Stuart Adam Mike Brewer Andrew Shephard. Outline. Poverty, inequality and redistribution Work incentives The trade-off. The income distribution. Big rise in inequality and relative poverty in the 1980s Greater private income inequality

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Work incentives and income redistribution

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  1. Work incentives and income redistribution Stuart Adam Mike Brewer Andrew Shephard

  2. Outline • Poverty, inequality and redistribution • Work incentives • The trade-off

  3. The income distribution • Big rise in inequality and relative poverty in the 1980s • Greater private income inequality • Regressive tax and benefit reforms Since 1997: • Big falls in child and pensioner poverty • Slight rise in relative poverty for working age without children • Little change in inequality • Despite strongly progressive reforms

  4. Who? • Working adults only • Excluding those in families where someone is aged over 55 or receiving a disability benefit • 17.8 million people (in 2005) • out of an adult population of 47.3 million • Analyse micro-data from large-scale surveys • TAXBEN run on FRS and FES data

  5. What? • Family income • Personal direct taxes and benefits only • ignore indirect taxes • ignore employer NICs • Ignore non-take-up of benefits and tax credits • Ignore other costs and benefits of working • childcare costs particularly important

  6. Two aspects of work incentives • The incentive to work at all • compared with not working • the ‘unemployment trap’ • The incentive to progress in work • ie increase earnings • this can mean more hours or higher wage • the ‘poverty trap’

  7. The incentive to progress Effective marginal tax rate (EMTR) • percentage of a small change in earnings taken in tax and reduced benefits

  8. The incentive to work at all Replacement rate (RR) • percentage of net income replaced if stop working Participation tax rate (PTR) • percentage of gross earnings taken in tax or reduced benefits • 1 –

  9. Work incentives in 2005

  10. Work incentives in 2005

  11. Changes in work incentives

  12. Changes in work incentives Reflects changes in several things: • Wages • Rents • Tax and benefit system • Other things • demographics, savings, housing tenure, couples’ work patterns,… We can try to separate these out

  13. Change in median RR

  14. Change in mean EMTR

  15. Redistribution and incentives • There is a natural conflict • Support based on low income must be withdrawn somewhere • Borrowing provides only temporary relief • Managing this trade-off is a central policy challenge • We do not offer a ‘best answer’ • Don’t look at responses to incentives • Don’t make value judgements • Instead, we delineate the options

  16. Quantifying the trade-off • Historical comparisons not very informative • Too many factors to separate out • Focus on policy simulations instead • Simulate several ways to spend £2.2bn • Look at effect on incomes and work incentives • Ignore behavioural response

  17. Policy options (1) 3 archetypal extremes: • Tax cuts • Reduce all NICs rates by ½ percentage point • Means-tested benefits • Increase MTBs for non-pensioners by 18.6% • Non-means-tested benefits • Increase child benefit rates by £3.38 per week

  18. Policy options (1)

  19. Policy options (1)

  20. Policy options (2) There are more nuanced options: • Reduce benefit withdrawal rates • Reduce housing benefit taper from 65% to 36.1% • Strengthens weakest incentives to progress • But spreads means-testing (quite weak incentives) to many more • Only weakly progressive • Support low-income workers • Increase working tax credit by £518 per year (£1,036 for couples and lone parents) • Strengthens incentives to work at all (for first earner) • But weakens incentives to increase family income further • Helps the poor, but not the poorest

  21. Policy options (2)

  22. Policy options (2)

  23. Policy options (3) Two options for the child tax credit: • Increase child element • by £343 per year • Very progressive • But significantly weakens work incentives • Introduce a big-family premium • Extra £1,955 for families with 3 or more children • Only slightly less progressive • Little effect on work incentives • But maybe other disadvantages

  24. Policy options (3)

  25. Policy options (3)

  26. Paying for the reforms • All the reforms shown here are give-aways • The money must come from somewhere! • Raising it will hurt the poor and/or weaken work incentives • Think of these reforms in conjunction with a revenue-raising reform? • Increase all NICs rates by ½ percentage point

  27. Paying for the reforms

  28. Paying for the reforms

  29. Conclusions • Low-income people face weakest incentives • benefit / tax credit withdrawal, not taxes • Labour’s tax and benefit reforms have acted to weaken incentives on average • Current tax credit strategy continues this • But there is no easy solution!

  30. Work incentives and income redistribution Stuart Adam Mike Brewer Andrew Shephard

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