In-work Tax Credits For Poor Households Raise Incomes But Increase Divorce Risk

[Amethyst]

MEDIA BRIEFINGS
The Economic Journal 2009 IN-WORK TAX CREDITS FOR POOR HOUSEHOLDS RAISE INCOMES BUT INCREASE DIVORCE RISK
The Working Families Tax Credit (WFTC), which was introduced nearly ten years ago as the main package of in-work support for low-income families with children, had strong employment and divorce effects on married mothers in poor households. That is the central finding of new research by Professor Marco Francesconi and colleagues, published in the February 2009 issue of the Economic Journal.
The authors suggest that the increased risk of divorce for married women in poor households may arise from the improved employment position of single mothers as a result of the reform. This could have generated a valuable ‘outside option’ to mothers married to low-earning men.
The study, which uses longitudinal data on a large panel of British families to examine the impact of the 1999 tax credit reform on married couples, finds that:

• Overall, the financial incentives of the reform had virtually no effect on many aspects of the behaviour of married mothers: eligible and full-time employment, employment transitions, use of child care and divorce rates.
• But women’s responses were very diverse and depended on their partners’ labour supply and earnings.
• Women with middle- and high-income partners were unaffected by the reform.
• But mothers married to low-income men showed larger positive responses in employment, especially if they had younger children (of the order of 5 extra percentage points). They were more likely to remain in the labour force and had higher rates at which they entered it.
• While more likely to receive the tax credit (a 3 percentage point increase), mothers married to low-income men also increased their use of paid child care (by about 2 percentage points, a relative increase of 30%) and experienced a greater risk of divorce (a 2 percentage point increase, a relative increase of 160% in the divorce rate for these women).
• There were no significant responses among married men, regardless of their income.

The result that the WFTC had strong employment and divorce effects on married mothers in poor households is very important. These women are similar to single mothers and, as these findings indicate, they are more vulnerable to becoming single.
Indeed, the better employment position of single mothers as a result of the reform, in part through its more generous child care provision, could have generated a valuable ‘outside option’ to mothers partnered with low-earning men. This response could have been an unintended consequence of the reform, which may turn out to be important for the evaluation of the longer-term success of the reform itself.
An interpretation of this result is that the child care component of the WFTC might not have been strong enough to induce more couples with children into eligible employment and marriage. This is because both husband and wife had to work 16 or more hours per week in order to receive the child care credit of the WFTC.
This additional requirement may help explain why the estimated employment effects for married women with low-income partners are smaller than those estimated for single mothers. Moreover, while the improvement in the relative economic position of single mothers may have led to an increase in bargaining power of married women (especially those in poorer households), it also reduced the overall gains from marriage, resulting in a greater risk of family disruption.
ENDS
Notes for editors: ‘The Effects of In-work Benefit Reform in Britain on Couples: Theory and Evidence’ by Marco Francesconi, Helmut Rainer and Wilbert van der Klaauw is published in the February 2009 issue of the Economic Journal.
Marco Francesconi is at the University of Essex. Helmut Rainer is at the University of St Andrews. Wilbert van der Klaauw is at the New York Fed.
The analysis underpinning this study is based on longitudinal data drawn from the first 12 waves of the British Household Panel Survey (BHPS) covering the period 1991-2002. The BHPS is a large representative sample of British households, whose members are followed and interviewed annually. The sample used in the analysis includes 3,235 couples, of which 1,430 have dependent children during the sample period and the remaining 1,805 do not have children during the observation period.
In the past two decades, a number of industrialised countries – including the US, the UK, Canada and New Zealand – have used tax credits and work-conditioned transfers as a means of alleviating poverty without creating adverse incentives for participation in the labour market. In-work benefits achieve this goal by targeting low-income families with an income supplement that is contingent on work.
Eligibility is based on family income and typically requires the presence of children, reflecting that there are higher out-of-work welfare benefits for families with children, that such families have higher costs of working (childcare) and, perhaps, that such families respond more strongly to wage changes than those without children.
As part of this new architecture of public policy intervention, in October 1999, the UK government introduced the WFTC. Although the WFTC was replaced by new tax credits in 2003, many of its key principles remain operative to date.
For further information: contact Marco Francesconi on 01206-872765 (email: mfranc@essex.ac.uk); or Romesh Vaitilingam on 07768-661095 (email: romesh@vaitilingam.com).

[Amethyst]

Re: In-work Tax Credits For Poor Households Raise Incomes But Increase Divorce Risk

STRENGTHENING WORK INCENTIVES FOR LONE PARENTS
The current tax and benefit systems for lone parents in the UK and Germany are difficult to make sense of unless the governments in the two countries care a lot about the poorest lone parents and hardly at all about those with low levels of earnings. That is the conclusion of new research by Mike Brewer, Professor Richard Blundell, Dr Peter Haan and Andrew Shephard, published in the February 2009 issue of the Economic Journal.
Their findings are directly relevant to current debates about how to design welfare benefits, in-work tax credits and income tax rates for low-skilled groups. They indicate that work incentives for lone parents could be strengthened in the UK and Germany, but only if the governments cared less about the poorest.
The UK government is currently implementing policies that will make it harder for those with children aged 7 or over to receive state support if they do not look for work and accept suitable job offers. The authors suggest that a more efficient tax and benefit system could indeed take account of children’s ages, but not by the extreme measure of denying state support to lone parents with older children.
For example, in the UK, it might make economic sense to reduce slightly the support given to lone parents with school-age children who do not work and increase it for low-earning lone parents with school-age children.
In the UK and Germany, substantial cash transfers are made to lone parents with no income of their own. But as lone parents’ earnings rise, the value of these payments falls, weakening their incentives to earn more or to work at all.
In Germany, this arises because welfare benefits fall nearly euro for euro as earnings rise. In the UK, although the Working Tax Credit provides a generous subsidy to part-time work, it is often offset by aggressive means testing in programmes to subsidise rent and local tax bills. For those with higher earnings, income tax and social insurance contributions have a similar impact.
Less harsh means tests do less to weaken incentives to work at all, but mean lower tax revenue for the government; steeper means tests raise more taxes, but may lead some people to work less or not at all.
How the overall personal tax and benefit system should be designed to balance this trade-off depends on three factors: how generous overall the government wants to be; how responsive people are to financial incentives to work; and how much the government cares about redistribution.
Using existing information on the extent to which lone parents respond to financial incentives to work more or to work at all, the authors use recent developments in optimal tax analysis to examine the tax and benefit system for lone parents in the UK and Germany.
Their main finding is that the existing tax and benefit systems for lone parents are optimal only if the governments in the two countries care a lot about the poorest lone parents and hardly at all about those with low levels of earnings. This conclusion is driven by existing evidence that lone parents do respond to financial incentives when deciding whether or not to work.
The argument runs as follows. A small cut in benefits for lone parents who are not working would encourage some to start work. This would increase their income and save the government money; the drawback is that it would leave those lone parents who did not move into work a little worse off.
The fact that the UK and German governments have designed tax and benefit systems where the incentive to take low-earning or part-time jobs is so weak can only be explained, then, if those governments care a great deal about those poorest lone parents.
The model used by the authors can be reversed to design a tax and benefit system that makes a trade-off between these competing demands if one knows, or assumes, how much the government cares about the poor.
The authors find that, with weak preferences for redistribution, levels of support for low-earning lone parents should be similar to those for non-working lone parents in both countries, leading to average tax rates close to zero at low earnings. But they also suggest that a more efficient system could be designed if taxes and benefits took into account the age of children in the family.
In the UK, the authors estimate that it might make economic sense to reduce slightly the support given to lone parents with school-age children who do not work, and increase it for low-earning lone parents with school-age children, even if the UK government cared a great deal about the incomes of the poorest lone parents.
In Germany, the authors estimate that a similar reform would be sensible for those with pre-school-age children, but for those with school-age children, taxes should be raised on high earners to pay for extra support for low earners.
In the UK, the government is currently implementing policies that give more encouragement to lone parents who are on welfare to find a job, and make it harder for those with children aged 7 or over to receive state support if they do not look for work and accept suitable job offers.
The approach suggested by the authors can be seen as an alternative to this. Rather than, at the extreme, denying state support to lone parents with older children, they suggest that a reshaping of the existing benefits and tax credits might help bring about similar outcomes.

[Amethyst]

Re: In-work Tax Credits For Poor Households Raise Incomes But Increase Divorce Risk

WELFARE REFORM: THE IMPACT ON MARRIAGE AND CHILDREN
Welfare programmes like the UK’s Working Tax Credit – which target poor families with income supplements that are contingent on work – have increased employment among recipients. But according to a study by Jeffrey Grogger and Lynn Karoly, published in the February 2009 Economic Journal, such reforms need to be carefully designed since certain features can have either positive or negative effects on marriage and children.
For example, welfare programmes that give couples more flexibility over whether the wife or husband has to meet the work requirements increase marriage and reduce divorce. And programmes that require parents to work more but also provide for a more generous wage subsidy may increase family income and help improve children’s educational achievement.
Equally, programmes with different designs may discourage marriage, increase the risks of divorce and/or be detrimental to children’s wellbeing.
The study discusses how researchers would expect work-conditioned transfer programmes to affect marriage and children’s wellbeing based on economic theory. It also assesses the empirical research to see what has been found in practice.
In terms of marriage, there are two possible effects of requiring welfare recipients to seek work, according to researchers. Some programmes may be designed to give single parents more options, which may discourage welfare recipients from getting married. Other programmes may favour married couples by providing them more income through wage subsidies or provide flexibility by allowing them to decide who fulfils the work requirement.
When researchers examined studies done on two different welfare programmes in the United States and Canada, they found evidence that such programmes may either raise or lower marriage rates. Marriage increased under the programmes that gave couples flexibility in meeting the work requirement and fell under programmes that mandated that mothers worked a set number of hours.
Researchers say there are also possible conflicting effects of work-conditioned welfare programmes for child wellbeing. Children may be better off because of the increase in family income. At the same time, the requirement to work may reduce the time parents have to spend with their children, which could have detrimental, neutral or beneficial effects depending on the quality of the substitute childcare.
Examining results from the same two welfare reform programmes, researchers found some improvements in school achievement for elementary school-age children, with the impact being greater when the programmes did more to raise family income.
The programmes also increased the use of childcare, which may have limited the potential negative effects from an increase in parental work. There is also evidence of more detrimental effects on adolescents, even if their family income rises. There is little evidence to suggest that children benefit directly from the positive marriage effects of these programmes.
The empirical evidence for the study findings comes from evaluations associated with three social experiments: the Canadian Self-Sufficiency Program and two variants of the Minnesota Family Investment Program (MFIP).
Examples of the types of welfare programmes these findings may apply to include in the United States, the Earned Income Tax Credit and Temporary Assistance for Needy Families, and in the UK, the Working Tax Credit.