Financial Incentives to Work: Comparing Ireland and the UK T. Callan, C. O’Dea, B. Roantree, M. Savage Budget Perspectives 17 th June 2016

Introduction National and international policy focuses on “Making Work Pay” International comparisons based on “headline” numbers can be misleading Microsimulation needed for representative picture: SWITCH and TAXBEN (IFS)

Outline Budget Constraints Financial Incentive to be in Paid Work Replacement Rates, Participation Tax Rates Financial Incentive to Progress in Work Marginal Effective Tax Rates

Example budget constraint for single adult at UK and Ireland median wages, April 2015

Measuring the Financial Incentive to be in Paid Work Replacement Rate measures how much of in- work income is “replaced” when out-of-work In-work income €130, Out-of-work income €100, Replacement Rate = 77%

Wages in the UK and Ireland Employee wages lower in UK than in Ireland Less than €10ph: 30% in UK, 15% in Ireland More than €20ph: 26% in UK, 31% in Ireland Predicted wage for those currently out-of-work takes account of: Age, education, marital status, gender Unemployment lower in UK => selection <€10 per hour: 45% in UK, 26% in Ireland

Wider Range of Replacement Rates for Out-of-Work Individuals in the UK...

Frequency of High Replacement Rates among Unemployed Jobseekers RR CategoryIrelandUK 40 hours > > > >

Average Replacement Rates for Unemployed Jobseekers, by Family Type

Frequency of High Replacement Rates among Unemployed Jobseekers RR CategoryIrelandUK 20 hours > > > >

Frequency of High Replacement Rates among Inactive/”Home Duties” RR CategoryIrelandUK 40 hours > > > >

Average Replacement Rates for Economically Inactive, by Family Type

A different view: the Participation Tax Rate Replacement rate can be thought of as measuring the absolute strength of the financial incentive to be in paid work but conflates incentives created by wages and the tax & benefit system An alternative measure is the Participation Tax Rate (PTR): The proportion of earnings taken away in taxes and lower benefit entitlements when an individual moves into paid work Greater focus on role of the tax & benefit system in shaping incentives

Replacement versus Participation Tax Rates Partner in paid work (A) Out-of-work disposable income€100 (B) Employer cost if work€50 (C) In-work disposable income€130 Replacement rate = (A)/(C)77% Participation tax rate = 1-(C-A)/B40%

PTRs on average higher in Ireland

… though PTRs >70% more common in the UK

… and notable differences across family types Potential 1 st earners in couples with children have a stronger incentive to be in full-time work in Ireland than the UK UK benefit system relatively more generous to such out-of-work couples Potential 1 st earners in couples without children face weaker incentive to be in full-time work in Ireland In part reflects higher jobseeker payments for these families in Ireland … and way these withdrawn entirely from those in full-time work … but also UK’s system of earnings top-up for childless adults (WTC) Illustrates trade-offs policy makers can face balancing work incentives and redistribution

Finally, look at incentive to increase earnings Measured by marginal effective tax rate (METR) Proportion of a small change in earnings (as measured in cost to the employer) that is lost in taxes and forgone benefit entitlements Tells us about the strength of incentive for individuals to increase their earnings slightly through whatever means (hours, promotion, etc.) e.g: In Ireland, basic rate of income tax + USC + PRSI => METR = 37.7%

Highest METRs faced by high earners in Ireland … but low earners in the UK

Distribution of METRs in Ireland ~1/3rd face METR of 37.7% 1/4 face METR of 55.8% 1/5th face METR of < 30%

Distribution of METRs in the UK ~1/4 face METR of 37.1% ~1/4 face METR of 40.3% ~1/10 face METR of 49%

In Ireland, more face METR of 50%+

In Ireland, more face METR of 50%+ … but fewer face METR of 70%+

Conclusions Looked at financial incentive to be in paid work (RR/PTR) RRs quite similar on average, though greater dispersion in the UK PTRs higher in Ireland on average (especially for those currently in work & unemployed jobseekers) but again greater dispersion in the UK Design of benefit systems leads to weaker incentives for potential 1 st earners in couples without children in Ireland, and with children in UK Also looked at financial incentive to increase earnings (METR) Far more workers face a METR > 50% in Ireland: higher rate of income tax begins to apply at much lower level of earnings in Ireland But fewer face METR > 70% in Ireland: created by simultaneous withdrawal of multiple means-tested benefits in the UK Design of tax & benefit system has implications for work incentives Challenge for policymakers how to balance this with distributional aims