1. IFS Social security reforms and incentives Mike Brewer and Tom Clark Institute for Fiscal Studies May 22 nd, 2002

2. IFS Motivation Reforms changed incomes and incentives Ever-present trade off when designing tax- and-transfer system This talk –Asks how we should analyse changing incentives –Describes (not judges) the impact of Labour’s changes –Work in progress –comments welcome!

3. IFS What sort of incentives? Incentives... –...to work –...to work more or earn more –...to save –...to claim benefits/tax credits (?) –...to cohabit and marry (??) –...to have children (???)

4. IFS Evaluating impact of incentives: a hierarchy “Optimal income tax” literature –“Are Labour’s reforms optimal?” Estimate response to incentives, predict changes due to reforms –Not saying whether “incentives” are good or bad Describe change in incentives –Not saying whether “incentives” are bad –Nor predicting their impact

5. IFS Work incentives Idea: trade off paid work against money Summarising the impact of reforms –Marginal effective tax rates –Replacement rates –Average tax rates Use tax and benefit model

6. IFS Marginal tax rates, workers

7. IFS Change in marginal tax rates, workers

8. IFS How do marginal tax rates vary with earnings? Split earnings distribution into equal-sized cells –Calculate average marginal tax rate in each cell –Assume away extremes –X-axis not linear!

9. IFS Marginal tax rates and earnings, all workers

10. IFS Marginal tax rates and hourly wage, all workers

11. IFS Marginal tax rates, earnings and children

12. IFS Marginal tax rates, earnings and children

13. IFS The new tax credits and incentives New tax credits will change how families with children are means-tested For many families, awards based on past year’s income Income increases of under £2,500 will be ignored in the short-run

14. IFS Incentive to work at all Replacement rate –RR = [Income out-of-work / income in work] –Include partner’s income Average tax rate –What proportion of gross earnings is lost in tax and foregone benefits and tax credits? Results –Almost no change for those without children! –Improves for lone parents –Worsens for couples with children

15. IFS Marginal tax rates, over 65s

16. IFS Change in marginal tax rates, over 65

17. IFS Other incentives To partner –Not possible to have progressive tax, joint assessment and neutrality to presence of partner –Difficult to quantify impact of reforms –Change compliance or behaviour? To have children –Considerably increased financial support for children

18. IFS Support for children, lone parent, 1 child

19. IFS Support for children, couples, 2 children

20. IFS Conclusions – so far! Work incentives –Little changed for those without children –For those with children, depends on whether partner present and/or working –Remember “work” also means “increase earnings” Incentives to save for retirement complex Incentives to partner, have children, claim benefits altered, but hard to quantify

21. IFS End

22. IFS Work incentives, families with children RR, 40 hours RR, 40 hours, after reform ATR, 40 hours ATR, 40 hours, after reform Lone parent68%64%61%52% Couple, working 55%59%31%38%