The Poverty Trade-off: work incentives and income redistribution in Britain, by Stuart Adam, Mike Brewer and Andrew Shephard

Policy Press, Bristol / Joseph Rowntree Foundation, York, 2006, viii + 55 pp, paperback, 1 86134 863 0, £12.95

It would be difficult to better the first three paragraphs of this report as a description of the dilemma facing policy-makers:

‘If you offer someone money on condition that they have a particular characteristic, you give them an incentive to acquire or keep that characteristic. That is the fundamental source of the trade-off between income redistribution and work incentives that confronts all governments with a dilemma.

‘Concern for poverty or inequality motivates governments to want to redistribute income, but providing benefits on the basis of low income reduces the incentive for people on low incomes to work themselves out of that position (over and above additional disadvantages of means-tested benefits such as stigmatizing recipients, requiring burdensome form-filling and achieving less than full coverage among the entitled population). Similarly, cutting taxes on higher incomes encourages people to work to increase their income, but leaves behind those who do not do so.

‘Thus the two main ways for a government to help people with low incomes – providing them with support directly and encouraging them to earn more themselves – are in head-on conflict with each other. How best to deal with this conflict has long been one of the central questions facing academic economists and economic policy makers’ (p.1)

The researchers choose not to employ models which predict individuals’ employment market behaviour in relation to tax and benefit changes, but instead translate ‘work incentives’ as the financial reward for working compared with not working and as the financial reward for working harder compared with not working harder. They find that, among the demographic groups studied, lone parents have the weakest work incentives; that from 1979 work incentives have increased on average; that from 1999 changes in tax and benefits have weakened work incentives; and in particular that since then tax and benefits changes have caused incentives to progress (i.e., to work harder) to deteriorate ( – the incentive to progress being indicated by the effective marginal tax rate which, on average, has increased by 3% since 1999).

The researchers find an ambiguous picture when they ask whether in general a trade-off has operated between increasing work incentive and reducing poverty, but they find a clearer picture when they simulate tax and benefit changes. Here they find that changes which unambiguously strengthen work incentives take more from the poor than from the rich or give more to the rich than to the poor.

The report is full of useful research results which will be of interest to anyone who wants to study in detail the ways in which tax and benefit changes affect financial incentives to enter the employment market or to progress within it: and, whilst the authors are careful to outline the additional research needed on individuals’ labour market behaviour, on personal preferences, and on consensus over social goals, they are able to draw some useful policy conclusions. For instance, ‘while increasing Working Tax Credit would encourage the first person in a family to work, it would discourage them from progressing further …… lowering [benefit and tax credit] taper rates and increasing in-work support carry a real risk of moving people above the poverty line but then leaving vast swathes of them barely above that level’ (p.51). The report rightly suggests that ‘if such outcomes help to meet poverty targets, that is partly a reflection of the deficiencies of headcount measures of poverty’ (p.51).

The report lists a variety of policy options and particularly favours an increase in Child Benefit (pp.29-30) as this would reduce poverty in a government target group (families with children) and would not damage work incentives because Child Benefit is not withdrawn as earned income rises. A particular advantage of increasing Child Benefit is that ‘benefits accrue disproportionately to the poor’ (p.30).

Gaps in the report invite further (and I would say urgent) research in two areas:

It really is important to factor in individuals’ labour market behaviour. Whilst the models available are not perfect, they at least give us some idea how tax and benefit changes might alter actual behaviour and therefore give us a better estimate of work incentives than simply assuming that financial incentives translate directly into work incentives.

Given the report’s favourable verdict on Child Benefit as an important means of reducing poverty without damaging work incentives, and its suggestion that people without children ought not to have their work incentives weakened (p.50), it really is important to follow this report with a study of the effects which a Citizen’s Income would have both on work incentives and on the alleviation of poverty.

On the evidence of this careful report, we would have every confidence that this team of researchers could produce a further clear and reliable report which would contribute significantly to the necessary policy debate.