Duncan Garner had an interesting article in the National Business Review yesterday (gated), on work disincentives associated with social welfare (or social security). And interesting timing, given that I had just written about this a few days ago (see here). Garner wrote:
Until recently, Eric was on the DBP with three kids and was paid $850 a week by Work and Income. They lived in a state house and paid $125 a week because it’s income-related rent.
Life wasn’t easy but they could get by and Eric could drop off and pick up his kids before and after school and he was in control. Sure, the struggle was real but the state was there for him.
But he hated the example it set his kids and wanted to show them he went to work each day and paid his way...
So Eric picked up a 40-hour truck driving job and was slowly removed from the welfare system.
He was paid just over $30 an hour for the truckie job, which is well above the minimum wage and the new job took him all over Auckland. But then his state house rent went up by close on $200 because his income had gone up too.
Then came the killer blow. How was he to pay for the kids after-school care? In reality he’d never paid a cent for care before because it was always his job, as a solo dad on the DPB.
But now it could add another $200 to his weekly outgoings and, once you add the extra housing costs, it soon showed he was worse off working, by about $200 week.
He was better off signing back on to the DPB. He hasn’t done that and wants to make paid employment work.
This again illustrates the problem of high effective marginal tax rates. The effective marginal tax rate (EMTR) is the amount of the next dollar of income a taxpayer earns that would be lost to taxation, decreases in rebates or subsidies, and decreases in government transfers (such as benefits, allowances, pensions, etc.) or other entitlements. In this case, Eric earns more as a truck driver, but then gives up more in lost welfare and entitlements (including the new obligation to pay after-school care) than what he would gain in higher income. On a purely monetary basis, he is worse off.
Interestingly, Eric notes that there are substantial non-monetary benefits from working, and those offset the net monetary loss. Not everyone would feel that way, and that's why high effective marginal tax rates provide such a disincentive for working. I don't necessarily agree with all of the broader points that Garner makes in his article, but on this we do agree:
We need to redesign welfare so these perverse outcomes don’t take hold.
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