IFS Did the Working Families’ Tax Credit work? Analysing the impact of in-work support on labour supply and programme participation Mike Brewer, Alan Duncan, Andrew Shephard and María José Suárez

© Institute for Fiscal Studies, 2005 Outline The paper: evaluating impact of changes to in-work benefits (WFTC) on labour supply Take account of all tax and benefit changes between 1997 and 2004 Use structural ex ante evaluation, with validation from (internal and external) ex post evaluation results Focus is on initial 1999 WFTC reform: more recent tax credit reforms in 2003 not covered in the paper –Working Tax Credits for all low-wage workers –Child tax credits combining non-work related child payments

© Institute for Fiscal Studies, 2005 Aims & contributions of paper Use micro-data from before and after WFTC to estimate structural model of labour supply and programme participation –Structural model needed to disentangle impact of WFTC from contemporaneous tax and benefit changes –Data from before and after reform identifies changes in preferences for in-work benefits (“stigma”) –Similar to earlier work (Blundell et al, 1999 & 2000) –Funded by UK Inland Revenue –WFTC part of sustained assault on child poverty

© Institute for Fiscal Studies, 2005 More parents are working

© Institute for Fiscal Studies, 2005 The WFTC reform WFTC replaced Family Credit in October 1999 –Evolutionary reform –Weekly, requires 16hrs/wk work –Awards depend on hrs/wk, earnings of claimant & partner, capital, family structure & expenditure on formal, registered childcare Comparison with Family Credit –Lower withdrawal (“phase out”) rate –More generous –New childcare credit –Change in administration Aims: relieve poverty, encourage work and reduce stigma

© Institute for Fiscal Studies, 2005 Budget constraints for lone parent (change in in-work support only) Assumes 2 children < 11, hourly wage of £5/hour, no childcare costs, no rent, no child support

© Institute for Fiscal Studies, 2005 Budget constraints for lone parent Assumes 2 children < 11, hourly wage of £5/hour, no childcare costs, no rent, no child support

© Institute for Fiscal Studies, 2005 Budget constraints for a 2nd earner in a couple with children Assumes 2 children < 11, hourly wage of £5/hour, no childcare costs, no rent, no child support, partner earns £300/wk

© Institute for Fiscal Studies, 2005 To what extent can policies explain changing employment? Difference-in-differences/natural experiment –Compares outcomes of eligibles and non-eligibles –Difficult to isolate impact of specific reform Structural labour supply model –Estimate utility function of income-hours trade-off –Simulate effect of actual or hypothetical reforms

© Institute for Fiscal Studies, 2005 Specifying a structural labour supply model Where is an extreme value error. Heterogeneity enters model through and For lone parents, utility function defined over net income and hours: Approximate function by:

© Institute for Fiscal Studies, 2005 Methodology (continued) Budget constraint approximated by number of discrete points: lone parents choose hrs/wk point to maximise utility. With extreme value errors: Model additionally allows for: Unobserved work-related (fixed) costs Childcare costs Programme participation (hassle or ‘stigma’) costs

© Institute for Fiscal Studies, 2005 Methodology (cont) In couples, utility defined over total net income and individual hours choices: Women choose from Men choose from

© Institute for Fiscal Studies, 2005 Estimation Data: UK Family Resources Survey 1995–2003 Sample includes both pre- and post-treatment data –valuable both for identification and validation Missing wages & childcare expenditures pre- estimated Structural likelihood integrated over rph and the estimated distributions of wages and childcare costs Use a simulated ML technique: integrals replaced by averages over 10 random draws (independent errors)

© Institute for Fiscal Studies, 2005 Parameters (lone parents) Preferences for income –Increase with number of children, age of youngest –Decreasing in age and education attainment Distaste for work –Increases with number of children –Decreasing in age and education attainment Fixed costs of work –Higher with young kids –Vary by region Stigma costs –Vary with age of youngest –Increasing in age and education attainment –Rise after WFTC, then fall

© Institute for Fiscal Studies, 2005 Simulating policy reforms Use parameter estimates to simulate the effect of moving between two systems. For given random draws, can calculate preferred choice of weekly hours and programme participation Averaging over many draws gives transition matrix One can calibrate transitions probabilities on observed outcomes by drawing from conditional distributions of stochastic terms

© Institute for Fiscal Studies, 2005 Transition matrix: lone parents Non- participation Part TimeFull TimeTotal Non-participation Part Time Full Time Total Change in participation Change in hrs/wk (all) Change in hrs/wk (workers) Post-WFTC Pre-WFTC

© Institute for Fiscal Studies, 2005 Transition matrix: married women Non- participation Part TimeFull TimeTotal Non-participation Part Time Full Time Total Post-WFTC Pre-WFTC Change in participation (Overall) (Partner working) (Partner not working)

© Institute for Fiscal Studies, 2005 Ex ante evaluations: All reforms, Change in participation (ppt) WFTCAll reforms Lone Parents Married Women Partner working Partner not working Married Men Partner working Partner not working

© Institute for Fiscal Studies, 2005 How do ex ante evaluation results line up with other ex post studies? Effect on lone parents’ employment Effect on employment of parents in couples Gregg and Harkness (2003) All reforms affecting lone parents between 1998 and ppts (lone parents) N/a Francesconi and van der Klauw (2004) All reforms affecting lone mothers between 1998 and ppts in ppts by 2001 (lone mothers) N/a Leigh (2004)All reforms affecting parents in autumn ppt

© Institute for Fiscal Studies, 2005 Conclusions Model suggests WFTC raised labour supply of lone parents by over 5ppt, but other reforms reduced labour supply Smaller effect for couples –Decline in labour supply of women, increased labour supply from men in workless households –Non-WFTC reforms reduced labour supply “Natural experiment” result broadly agree for lone parents; less robust results for couples Recent reforms mean the incentive to work at all is –stronger for most lone parents –for adults in couples, more likely to be weaker than stronger –couples with children face larger incentive to have 1 worker and 1 carer Part of sustained assault on relative child poverty