- Welfare, Incentives, and Taxation
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Individuals are risk averse, and face uncertainty over future productivity and family composition but not over future tax and benefit systems. Individuals are unable to borrow except to fund education. In the model, women's work incentives are fully determined by the following factors: female characteristics: age, hours of work and wage which depends on her education, experience and productivity ; partner characteristics: presence of partner, hours of work and wage which depends on the partner's education, the age of the woman a proxy for the partner's age and the productivity of the partner ; child characteristics: presence and age of children; family characteristics: the level of rent paid and whether the family has to pay for childcare.
The model is estimated on an unbalanced panel of around 4, women and their families taken from the British Household Panel Survey BHPS over 16 waves, — Estimation is performed using the method of simulated moments MSM.
Having estimated the model, we simulate full life cycles for 22, women and their families. When performing these simulations, we assume individuals face a single tax and benefit system throughout life; we use the UK system in existence in April This allows us to focus on the effects of a particular tax and benefit system, rather than worry about individuals being exposed to different tax and benefit systems at different stages of life.
The model also effectively strips out cohort effects. With the model, we then calculate two standard measures of work incentives: the marginal effective tax rate METR , which describes what fraction of an incremental change to gross family earnings is lost by the family through increased tax liabilities and reduced benefit entitlements; and the participation tax rate PTR , which describes what fraction of the change in gross earnings caused by one adult moving into work is lost by the family through increased tax liabilities and reduced benefit entitlements.
We calculate the METR by increasing labour supply by one hour per week. The METR has little practical relevance for those not working because we observe essentially no one in the data working just one hour a week and so we condition on being employed when calculating the METR at observed hours. We ignore consumption taxes and social insurance contributions made by employers and we ignore the fact that payment of social insurance contributions may increase future entitlement to insurance benefits.
Appendix B online gives the full definitions and details of these calculations.
Welfare, Incentives, and Taxation
On the other hand, we also ignore the disregards in the tax credit system that in practice mean that tax credits may not respond in the short run to changes in earnings. The model's focus on the dynamic implications of human capital choices and labour supply choices means that some simplifications are made when modelling other processes.
For example, and as detailed in Appendix C , the earnings and labour supply of any male partners both follow a simple and exogenous process; family formation and dissolution, and fertility, both depend on women's education but are otherwise exogenous. The demand for childcare is given by a family's working patterns, and the price is exogenous. Finally, although the model allows for saving, housing tenure is fixed across people's lives. In contrast, we consider behaviour under a single tax and benefit system, allowing us to draw cleaner conclusions about work incentives given optimal behaviour under that system.
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This section gives an overview of the tax and benefit system in the UK as of April with a focus on the features of the system that are relevant given our concern over how the system affects work incentives. There is more detail in Appendix A online. Table 1 compares the yield of the two main taxes, and the expenditures on and recipients of the five main welfare programmes and tax credits. The two main personal taxes on earnings are income tax and National Insurance, both of which are assessed at the individual level.
The cash benefits and refundable tax credits can be thought of as forming two groups: those designed to replace or top up earnings, and those designed to compensate for different needs.
Maximum entitlements to all these benefits depend upon family circumstances, being mostly higher for couples than for single adults. The group designed to compensate families for particular needs includes child tax credit, housing benefit including local housing allowance and council tax benefit. As explained in Appendix A online, the maximum entitlement to these benefits depends on the number and presence of children, whether the household is renting or not and, if so, the amount of rent paid , and the liability to the local property tax, known as council tax.
The way that the personal taxes affect work incentives is fairly intuitive, but the cash benefits and refundable tax credits affect work incentives in much more complicated ways, meaning that the impact they have on a given individual's work incentives will depend on the earnings of any partner and on other family or household characteristics, such as housing tenure and the presence and age of children. They highlight three things. The analysis is in three stages. First, we show how work incentives vary across the population, with a focus on how they are different for women in different family circumstances.
We remind the reader that the observed patterns are driven in part by variation in tax rates across family composition and in part by differences in labour supply across family composition: we are providing a descriptive analysis of the incentives that women would actually face given their optimal responses to the given tax and benefit regime. A striking feature is the fact that more than 70 per cent of working women have a METR of 32 per cent. Table 2 shows which taxes and benefits are responsible, on average, for different ranges of METRs.
The modal rate of 32 per cent is made up of the standard rate of income tax 0. Table 2 also shows that weak work incentives a METR in excess of 0. Individuals with relatively strong incentives to work low PTRs typically have a working tax credit award that offsets the loss of income support when moving into work.
Those with weak incentives to work, with PTRs in excess of 0. Figure 4 shows how work incentives differ by family type, classifying women into one of single adults without children, adults in couples without children, lone mothers, and adults in couples with children. There are clear differences by family type. Women in couples without children generally enjoy the strongest work incentives: over 90 per cent have METRs of 0.
These arise for two reasons. The second reason is that women with partners but no children are unlikely to be entitled to cash benefits were they not to work — entitlement to which can lead to high PTRs — because most have partners who are themselves in work. Almost all childless single women have PTRs of at least 0. These differences reflect not only differences in how the UK tax and benefit system treats different sorts of mothers, but also the different choices made by women at different stages of their life cycle who are also facing different patterns of work incentives because of the tax and benefit system.
Figure 5 shows differences in work incentives by education level. Of course, education has no direct impact on tax liabilities and entitlements to cash benefits; instead, any differences are due to differences in employment, wages and family circumstances between education groups. Women with low levels of education are more likely to have METRs above 0. Both reflect that women in the low education group tend to be less well paid and more likely to be lone mothers; as Figures 1 and 2 showed, lone mothers tend to face reasonably strong incentives to do some work low PTRs , but relatively weak incentives to work more high METRs amongst workers due to withdrawal of refundable tax credits and cash benefits.
The previous subsection showed the considerable variation in incentives across the population and that a large amount of the variation relates to family circumstances. Figure 6 plots the mean and various quantiles of the METR for employed women by age in the left panel and how family type changes by age in the right panel.
Although the 10 th , 25 th , 50 th and 75 th percentiles of the distribution of METRs remain constant at 0. The right panel in Figure 6 shows that this coincides with a large rise in the share of families with children; as we saw in Figure 4 , women with children particularly lone mothers generally have higher METRs than those without.
The left panel of Figure 7 shows that there is a slight downward trend and a narrowing of the distribution over the life cycle, both of which are consistent with wages increasing with age due to experience effects; there is no secular wage growth in the model. These aggregate changes by age hide considerable variation by education. Figure 8 shows that the dispersion of the METR is much less marked for the high education group than for the low education group: the 75 th percentile of the METR for the high education group remains at 0.
It is also the case that the high education group have substantially lower dispersion in their PTRs throughout the life cycle than the low education group, but there is somewhat less of a downward trend see Figure 9. To explore further the differences between family types, Figures 10 and 11 repeat this analysis of how METRs and PTRs change by age, but conditional on women being in a specific family type. Instead, we interpret the figures as showing the differences between older and younger women of a given family type.
Tax, Welfare and Inequality – The International Centre for Tax and Development (ICTD)
For example, Figure 10 shows there is little difference between the distribution of METRs for younger and older women who do not have children. However, among women with children, the general pattern is for METRs to be lower where the mother is older. Amongst those with children, older lone mothers tend to have higher PTRs than younger ones, and older mothers in couples tend to have lower PTRs than younger ones.
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Appendix Figure D. An interesting question is the extent to which there is a correlation between work incentives and labour supply elasticities across the life cycle: do taxes and benefits reduce the return to work more at ages when women's labour supply is most responsive to changes in wages? The answer is mixed.
They highlight three main findings. Relating this to our results, we see that women tend to face higher METRs at ages when their labour supply is most elastic. Ethics in Value Theory, Miscellaneous. Edit this record. Mark as duplicate. Find it on Scholar. Request removal from index. Revision history. This entry has no external links.
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Oxford University Press. Beware of Economists Bearing Advice. Research under this theme focuses on developing a better understanding, in specific contexts, of the complex economic and political linkages between how governments tax, how their national economies perform, and how well their citizens live. Some of our specific concerns are: the taxation of high net worth individuals; efficient business taxation; and the taxation of socially-harmful activities like smoking tobacco.
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This paper examines the potential for changes in the tobacco tax to contribute to raising government revenues, reducing tobacco use, and improving public health in Nigeria.