The UK Child Benefit Implementations - Example

Full UK Child Benefit Implementations UK Child Benefit Implementations Introduction UK welfare comprises of a wide range benefits for the families to help with the extra costs of children. These include benefits for women who are pregnant or just had their baby, for the partners of women who have given birth, benefits for people who adopt, and benefits for children, tax credits and other help such as 1) Benefits for maternity example, Statutory Maternity Pay and Maternity Allowance, 2) Benefits for paternity example, Statutory Paternity Pay, Income Support during paternity leave, Paternity and Jobseeker’s Allowance and Parental leave, 3) Benefits for adoption, 4) maternity grants from the Social Fund, 5) Benefits for children example, Child Benefit, 6) Guardian’s Allowance, 7) Help for disabled children example, Disability Living Allowance, Community care and Transport options for disabled people 8) Child Tax Credit, 9) Help with the costs of childcare example, Childcare vouchers, Sure Start and Child Trust Fund 10) Other help with the costs of bringing up children example, benefits for the low income families with health, education and legal costs (HMRC, n.d.). In January 2013, child benefit program was reformed. Accordingly, higher-income families are required to pay extra tax to keep receiving the child benefit. The current study examines the impacts of changing the child benefit program on household labor supply decision. What was changed in January 2013 After the changes introduced in January 2013 Child Benefit was still open to everyone but discriminated on high income families. If both partners have an income below £50,000 a year, the changes does not affect them. Those families continue to receive the full amount of Child Benefit without having to pay extra tax. Those who earn more than £50,000 a year are required paying extra taxes that effectively cancel out some or all of the Child Benefit progressively. If either mother’s or father’s income level is £50,000 a year the minimum tax amount is payable. The tax amount increases with the income level and cancel out the full benefit at £60,000 limit. Moreover, it is not taken into account the combined family income when calculating the tax payment. If one of the partners has an income over £50,000 a year, the extra tax has to be paid even if the other partner is unemployed and receives no income at all. If both the partners have an income over £50,000, whoever has the higher income has to pay the extra tax to receive the Child Benefit (HMRC, n.d.). Transfers represent a very large fraction of disposable income for the bottom deciles in all the European countries. However, the proper amount of redistribution and the design of transfer programs are important because redistribution gives rise to a trade-off between equity and efficiency (Immervoll et al., 2007). The objective of the current study is to examine the impacts of the new Child Benefit program in the UK on labor supply decisions for a single mother with two children who is able to find work at £30/hour. Standard labor supply model is applied for the study. How is the extra tax calculated? The amount of extra tax an individual has to pay upon receiving Child Benefit is known as the “High Income Child Benefit Charge.” It is calculated based on the “adjusted net income” which is defined as the sum of individual’s wages, profits from self-employment, savings interest and rental income excluding certain deductions such as the pension contributions and Gift Aid donations to charities. The “High Income Child Benefit Charge” is 1 per cent of the amount of Child Benefit for every £100 of income above £50,000. If the income is more than £60,000, the amount of the extra tax is the same as the amount of Child Benefit the household gets. Affected beneficiaries should declare that they will continue to receive the Child Benefit and pay the High Income Child Benefit Charge. It can be paid as a lump sum through self-assessment or through the tax code under pay in installments (PAYE). Households can receive Child Benefit without having to pay the High Income Child Benefit Charge by reducing the individuals “adjusted net income.” For example, Pension contributions and childcare vouchers are deducted from the income for calculating the adjusted net income. Therefore, individuals may increase their investments on pensions or opt to receiving some of the income paid in the form of childcare vouchers to stay below the £50,000 income limit (HMRC, n.d.). Literature Review Redistribution of income from middle and high categories to the poor is considered as desirable for equity reasons. In general, the society puts a higher value on the marginal consumption of the poor compared to the marginal consumption of the well-off. However, redistributive programs also reduce the incentive to work, thereby creating efficiency costs. Redistributing one additional euro from high-income earners to low-income earners, incurs a cost that is larger than one euro and the government needs to impose this cost on those households with high incomes. Therefore, greater social taste for redistribution implies larger transfer programs and higher taxes are desirable (Immervoll et al., 2007). Most studies on the welfare cost of taxation have adopted labor supply model (Ballard, 1988; Browning and Johnson, 1984; Dahlby, 1998; and Immervoll et al., 2007). Optimal income tax theory in labor supply framework shows that redistribution should take the form of a Negative Income Tax (NIT), where a lump-sum transfer given to beneficiaries phase out with increasing the level of income. For example, the RMI (Revenu Minimum d’Insertion program provides 400 euros per month for a single person with no income and is phased out at a rate of 100%. Negative Income Tax programs impose a positive tax burdens on middle and high-income households in financing for the welfare of poor. Financing transfers by the earnings of middle and high-income category creates a simple explicit trade-off in the design of the welfare program. The size of the transfer program and the level of taxes on middle and high incomes earners positively influence the redistributive strength of the social welfare program. However, the elasticity of labor supply with respect to net-of-tax wage rate in the labor supply model shows that labor supply is affected with the increasing tax burden. For example, Krueger and Meyer (2002), revealed that benefits raise the incidence and the duration of unemployment, and that the elasticity of lost work time with respect to benefits tends to be around one in Organisation for Economic Co-operation and Development (OECD) countries. Therefore, the proper amount of redistribution and the design of transfer programs is an important and controversial issue. For most European countries, expanding the welfare programs creates large efficiency costs. Immervoll et al., 2007 divided EU countries are into three groups and analysed the comparative tax rates. It was concluded that tax rates are highest in Nordic countries (Denmark, Finland, Sweden), relatively high in continental Europe (Austria, Belgium, France, Germany, Luxembourg, and the Netherlands) and lowest in Anglo-Saxon and Southern European countries (Greece, Ireland, Italy, Portugal, Spain, and the UK). Nevertheless, the contribution of benefits to the disposable income of the lowest income decile group in Anglo-Saxon and Southern European countries is significantly higher compared to the other EU countries. In general the cost of redistributing one additional euro to low-income individuals to increase their welfare benefits requires costs 2 to 4 euros of welfare reduction in the high-income individuals depending on the value of the labor supply elasticities in the country. Therefore, most European countries have imposed large tax rates on the participation margin at the bottom of the earnings distribution (Immervoll et al., 2007). The following table which was adopted from Immervoll’s labor supply study shows the significance of transfer payments in the disposable income of the poor in selected European countries (Table 1). Decile group European Union country Netherlands (%) Germany (%) Finland (%) Ireland (%) United Kingdom (%) 1 67.6 72.6 74.0 94.5 83.2 2 49.2 45.7 64.3 74.2 67.9 3 33.2 28.4 55.7 63.3 52.7 4 19.7 23.8 43.2 42.6 31.6 5 19.4 17.9 39.5 24.3 22.6 6 12.6 15.1 34.7 16.3 12.5 7 9.6 11.0 29.2 10.9 8.1 8 6.1 9.4 25.0 8.5 6.4 9 7.0 7.0 20.5 5.1 3.3 10 4.2 4.5 13.1 1.9 1.6 Total 13.9 15.1 30.1 15.7 12.9 Table 1: Total Social Benefits as a Percentage of Disposable Income by Deciles Source: Welfare Reform in European Countries:A Microsimulation Analysis, in “The Economic Journal” (2007, p.2) Cogan, (1981) explained discrete changes in labor supply behaviour using fixed costs of working. This study showed that fixed costs of working such as child care expenses (monetary costs) and commuting time (loss of time) are particularly important for the labor supply behavior of married women. Alternative policies encourage labors to participate in the work force such as the Working Families Tax Credit (WFTC) in the UK which was designed to induce lone mothers from welfare into work. The studies show that the participation rate of single women with children in the labor force increased by 5 per cent after implementing this policy (Blundell et al., 2000). Conceptual Model The current study adopts the labor supply model estimated by Immervoll, 2007, using EUROMOD. Accordingly, the optimum labor supply choice for an individual in group j can be given by Where denotes hours of work for a participating worker in group j, is the marginal tax rate for group j, and Wj denotes the net-of-tax wage rate. The optimal hours of work depend only on the marginal net-of-tax wage rate (p.8) The intensive labor supply elasticity for an individual in group j can be given by, The aggregate labor supply of group j is thus equal to Where is the extensive elasticity and is the distribution function of the fixed cost in other words the number of individuals who decide to work. The current study employed extensive elasticity of labor supply values estimated by EUROMOD which is an EU-wide microsimulation model. EUROMOD is built around partly harmonized household datasets describing the population of European Union Countries. It captures the full range of institutional features of tax and benefit systems including income definitions such as the “adjustable income” (Immervoll, 2007). Labor supply elasticities are strongly heterogeneous and correlated across income decile (p.14). Calculations The hours-of-work elasticity is assumed to be constant across income deciles in the present analysis (Diamond, 1998 and Saez, 2001). It was also assumed that adjustable income is equal to the net-of-tax wage rate and contributions to the pension and charities etc. were ignored. The value of elasticity which is equal to 0.1 was adopted followed by Immervoll, 2007. In the empirical analysis the labor supply decisions for a single mother who is able to find work at £30/hour rate was considered. Labor supply before imposing High Income Child Benefit Charge Labor supply before imposing High Income Child Benefit Charge Where t= 1% for each unit above the limit £50,000 per year. Therefore the change in labor supply can be given by Hours Conclusions All European governments provide a number of benefits and transfers providing financial support to individuals and families with certain characteristics such as low income, unemployment, old-age or the presence of children. However, the research findings show that tax incentives have quite substantial effects on labor force participation (Krueger and Meyer, 2002). Most of the labors countries contribute to pension and other charities but those were ignored in the present simulations. The calculations revealed 270hours loss of work at 0.1 hours-of-work elasticity level. Loss of labor due to imposing taxes is in consistent with many empirical literature estimations done by the previous researches. It should be emphasised however that pension and other contributions made by the workers affect the Child Benefit and hence the loss of labor hours calculated in the current study is an over estimation. References Ballard, C.L., 1988. The marginal efficiency cost of redistribution. American Economic Review, 78(5) pp. 1019–33. Blundell, R.W., Duncan, A., McCrae, J. and Costas, M., 2000. The labor market impact of the working families tax credit. Fiscal Studies, 21(1) pp. 75–104. Browning, E.K. and Johnson, W.R., 1984. The trade-off between equality and efficiency. Journal of Political Economy, 92(2) pp. 175–203. Cogan, J.F., 1981. Fixed costs and labor supply. Econometrica, 49(4) pp. 945–63. Dahlby, B., 1998. Progressive taxation and the social marginal cost of public funds. Journal of Public Economics, 67(1) pp. 105–22. Diamond, P.A., 1998. Optimal income taxation: an example with a U-shaped pattern of optimal marginal tax rates. American Economic Review, 88(1) pp. 83–95. Immervoll, H., Kleven, H. J., Kreiner, C. T., and Saez, E., 2007. Welfare reform in European countries: a microsimulation analysis. The Economic Journal, 117(516) pp. 1-44. Krueger, A.B., and Meyer, B.D., 2002. Labor supply effects of social insurance in (A.J. Auerbach and M. Feldstein, eds.), Handbook of Public Economics, 4. Amsterdam: North-Holland. which you may be able to get when you have responsibility for a child or young person.Child Benefit program in the UK is a payment that can be claimed by anyone who is responsible for a child, every four weeks or weekly regardless of their level income or savings. Separate rates apply for each child beneficiary. It is open for anyone who qualifies, If youre responsible for a child, you can normally get Child Benefit for them - even if youre not their parent. You can get Child Benefit even if your child doesnt live with you, as long as: you pay towards their upkeep what you pay is at least the same as the amount of Child Benefit the person your child lives with is not getting Child Benefit for them If you and another person both claim Child Benefit for the same child, only one of you can get it. Child Benefit payments usually stop when your child reaches 16, unless they are in education or training that counts for Child Benefit. For example, an advanced course at higher education level - such as a degree - doesnt count. You cant get Child Benefit for your child once they reach the age of 20. (. Read More