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Tax credits: time to stop weakening work incentives?

Tax credits: time to stop weakening work incentives?. Mike Brewer, Institute for Fiscal Studies. Outline. Recent tax credits changes are weakening incentives to work Can we reduce child poverty without weakening work incentives?. Background.

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Tax credits: time to stop weakening work incentives?

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  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to rich) weaken work incentives • Out-of-work income rises, in-work income rises less • EMTRs rise because transfer withdrawn as income rises EMTR = effective marginal tax rate = how much of a small change in income is lost to extra tax and reduced transfers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

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