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How Taxes and Benefits Can Discourage Work (A Theological View)

Kairos Journal:
In Britain, as in most other Western economies, the government administers a bewildering range of taxes and welfare benefits in its efforts to achieve a number of ambitious objectives—the relief of poverty through redistribution of income towards the long-term poor;

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How Taxes and Benefits Can Discourage Work

In Britain, as in most other Western economies, the government administers a bewildering range of taxes and welfare benefits in its efforts to achieve a number of ambitious objectives—the relief of poverty through redistribution of income towards the long-term poor; social insurance to help mitigate the effects of the great hazards of life (e.g., unemployment, family breakdown, and long-term illness or disability); and an attempt to smooth out income levels over an individual’s life cycle.¹ On the face of it, these are laudable aims, approved by many Christians. But they have a number of unintended and not-so-beneficial consequences, not the least of which is the way this tax/benefit system discourages work.

This can happen in two ways. First, working people on low incomes may be dissuaded from working longer hours, getting a second job, or getting a slightly better job. The problem is simply that they may gain very little financially. A “poverty trap” comes about when a person’s gross earnings from working harder increase while his or her net earnings (after income tax and national insurance deductions and the loss of welfare benefits) amount to little or nothing—or even a loss. Second, the “unemployment trap” occurs when living idly on benefits is more lucrative than holding a job.²

Consider this poverty-trap example: A couple with no children earns together just £14,000 annually. For the financial year 2009-2010, they pay £548 in combined tax and national insurance contributions. Over the same period, they receive a state welfare benefit for low-income working families (the “working tax credit”) of £1129. This gives them a net income of £14,581. But if they decide to work longer hours and increase their combined pay to £16,000 a year, their tax and national insurance contributions would increase to £1,168, whilst their working tax credit would fall to £569.³ This leaves them with a net household income of £15,431. So although they gain an extra £2000 from work, they are only £820 better off. In other words, they pay an “effective” tax rate of 59% on the extra income.

A 2006 study by London’s Institute for Fiscal Studies⁴ found that over two million workers stood to similarly lose more than half of any small increase in their earnings. And around 160,000 would actually lose 90%—far higher than the marginal tax rate on the wealthiest people.⁵ The study concluded that although the government had pledged to “make work pay,” the extension of means-tested benefits actually exacerbates both the poverty and unemployment trap, increasing the disincentive to work.

Christians know from their study of the Bible that work is both a duty and a blessing, so there must be something seriously wrong with government policies which, innocently or not, end up discouraging people from more employment.

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