More on Welfare and Incentives

Again from Rodney Hide. This numerical example highlights what we try to teach about the marginal rates of taxation and the incentive effects of many welfare programmes.

[A] family with 2 children, on $35,000 a year, with housing costs of $300 a week, will have a -17% tax rate. They get net $788 a week.

If this family works longer hours, or Mum goes to work, and they earn $20,000 more lifting them to $55,000, they only get net $837 a week. For $20,000 gross extra earnings, the family gets only $2,548 net a year. So despite earning $400 more a week, the Government takes $350 - they get $50.

That is a tax rate of 89%. It is composed of 33 cents statutory tax, 30 cents off Family Support, 25 cents off Accommodation Supplement, 1.2 % ACC.

The problem for this family is how do they set about to improve their lot? What is their incentive to lift their income and raise their income?

This serious trap is far worse if any of the families in this situation are also amongst the hundreds of thousands of New Zealanders with Child Support and/or Student loan debts. If they are, their effective tax rate will exceed 100%, and over 113% if they have both.

Marginal rates of taxation in the range of 89% to over 100% are very effective ways to reduce incentives to work and earn more; it is little wonder they call it the "welfare trap". For more on the distortions created by the welfare system, see here and this link to my previous posting on this topic.