Today the BBC reports that child benefit is to be axed for higher-rate taxpayers.
Some background: ideally, a person's tax liabilities reflect his or her ability to pay taxes. Most tax systems recognize that having children reduces ability to pay, so provide parents with some kind of tax relief.
In the late 1970s, the British government changed its "child tax allowance" - a tax deduction generally claimed by the higher income parent - into a child benefit, received by the mother. The policy provided greater benefits to lower income parents, who did not earn enough to benefit from the child tax allowance, and put income in the hands of mothers. It made a difference: Shelley Lundberg, Robert Pollak and Terry Wales found that families began spending more money on goods for children after child benefits were introduced.
The latest announcement means that "any couples where one parent earns about £44,000" will have to repay some or all of their child benefit.
The policy can be criticized on fairness grounds - yes, people earning, say, £60,000, are comfortably off. But within that income group, people supporting children have less ability to pay tax than people without such responsibilities. There is an equity argument for recognizing that lesser ability to pay.
And as Nick Rowe and I argued in "The efficiency case for universality" , taxing back child benefit is inefficient, as well. Here is a non-technical summary of our argument. It is based on the concept of an "effective marginal tax rate":
The first thing to realize is that people care about the total tax/benefit package they receive from the government. That is, they care about their “effective taxes,” not their taxes or benefits alone. If I pay $10,000 in taxes and receive benefits worth $3,000, my effective taxes are $7,000. Both tax policy and social policy involve giving benefits and taking income away. The two are intrinsically linked, and must be considered simultaneously.
...what distorts economic decisions is the marginal tax rate. A person who loses $40 in benefits for every $100 of extra income they earn faces exactly the same disincentives as one who pays an extra $40 in taxes. Both face a 40 per cent effective marginal tax rate. The “clawback” of benefits raises effective marginal tax rates, creates disincentive effects and distorts economic decisions in exactly the same way taxation does.
Recognizing that taxing back benefits is the same as raising tax rates is the key to understanding why benefit clawbacks are inefficient:
We define universality to mean that the same benefits are paid to rich and poor alike, and are not taxed back from the rich. In a tax/benefit system with universality, therefore, individuals with the same market income face the same effective marginal tax rate.
With targeted benefits, on the other hand, people receiving benefits face clawbacks, and therefore pay a higher effective marginal tax rate than people with similar incomes who do not receive benefits. Which tax/benefit system is best: one with universality, or one with targeted benefits?
A government aiming to maximize social welfare must balance efficiency considerations, which argue for low tax rates, with equity considerations, which argue for the higher tax rates needed to finance redistributive social programs. We do not know — we suspect no one knows — what an optimal tax rate schedule would look like. But it seems very unlikely that either efficiency or equity requires radically different tax schedules for Canadians with and without dependent children.
And that is why Britain's proposed child benefit taxback is inefficient. If more revenue is needed - it is predicted that this change will save £1 billion a year - it could be raised efficiently by increasing taxes on all people earning over £44,000 by a small percentage. The efficiency impacts of such a small change would be negligible. Raising the tax rates on just some of those taxpayers 5 or 10 percent is much more likely to distort people's work choices.
And that is the efficiency case for universality.