Monday, November 16, 2009

No Incentive to Earn More

A few weeks ago, I wrote a post about - Better off on Benefits.

It reflects a problem common to many Western democracies. - Many tax and welfare policies designed to reduce relative poverty have the unfortunate side effect of giving low income earners no incentive to get a better paid job / work longer hours.

The reason is that when a worker gets a better paid job, they pay more tax and lose means tested benefits. So there net take home pay is often no better than before. If their take home pay remains the same, we say their effective marginal tax rate is 100%

It is actually quite hard to find statistics which consider the impact of welfare benefits and taxes. Maybe the government doesn't want to publicise how the tax and benefits often create zero incentives. I would guess that most people would assume working longer hours / getting higher paid should lead to higher incomes.

This is an interesting graph showing earned income less taxes, plus a variety of benefits. Note, this is for a typical family of three in Virginia. A single adult would, for example, be entitled to less benefits aimed at children.

Source - Mises.org: which also shows implicit marginal tax rates. Via G.Mankiw
Note: Mises is a right wing think tank noted for its scepticism of government intervention; the example chosen may have been to highlight their point. But, the principle of 100% marginal tax rates is often correct and it does have important implications for policy.

If I had lots of spare time (which unfortunately I don't) I would try to create similar graphs for the UK. But, I have to say, it would be a very time consuming job.

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