Monday, November 21, 2011

The Economics of Child Benefit

Today the Irish media was full of speculation that there may be a cut to child benefit in the upcoming Budget. Also, following on from the speculation: debates around means-testing and universality surfaced again. The last time I can remember this topic (and associated issues) being discussed was when Liam posted on the Irish Economy blog: more than a year ago at this stage. Liam mentioned George Osborne's decision to axe child benefits from top-rate taxpayers in the UK. Effective from 2013, George Osborne said that his measure would affect people earning more than £44,000 a year.

For a re-cap on Osborne's initiative, this BBC story is useful. As to how Osborne will implement the clawback, the story says that: "any higher-rate taxpayers in receipt of child benefit may be asked to declare this fact on their self-assessment tax returns, implying they would then face an extra tax charge. It might be simpler for HM Revenue & Customs (HMRC), which administers the child benefit system, simply to cross-reference claimants against their tax records." These are two approaches which would be distinct to means-testing; the former is a self-declaration; the latter assumes automatic enrolment into eligibility-assessment. Another way of thinking about the latter approach is that it involves parents being automatically enrolled into the scheme; and the onus being on the government to de-enrol parents. I tried to find more up-to-date information about the potential implementation strategy for the UK; but nothing else has come to my attention so far.

To re-cap on the Irish situation, the following excerpt from Liam's Irish Economy post is useful:
"Rates in Ireland are approximately €150 per child per month (but vary with family size) and are paid universally regardless of family income for each child aged under 16 or under 18 and in full-time education. Like any universal payment of this nature, there is the obvious question as to why people on higher incomes should be receiving a transfer payment from the state. A less obvious question is what we mean by higher incomes and where the threshold should be set. Expenditure on this scheme is approximately €2.3 billion in Ireland... If we do have to cut, then I would rather it be from... schemes like child benefit that don’t have an obvious reason to be universal -- rather than from well-targeted schemes."
In the comments below Liam's post, Kevin (Denny) makes an argument against means-testing: "When you means-test, benefits take-up falls significantly: in other words people who are entitled to benefits... end up not receiving them, see for example Blundell, Fry, Walker (EJ 1988); which reports take-up rates for housing benefits between 50-70%. The Institute for Fiscal Studies has done a lot of work on this... Stigma may play a part in (the) non-take up." There is also a more recent paper in Social Science and Medicine (Stuber and Schlesinger, 2006) which produces a similar result: that there may be stigma attached to means-tested government programs.

The topic of child benefit was also raised on the Irish Economy blog by Philip Lane, almost two years ago at this stage. Philip links to an Irish Times article by Tim Callan and Brian Nolan. Unfortunately the Irish Times article (Tax on Child Benefit Fairest for Low-Income Families) is behind a pay-wall. However, it is essentially a comparison of the options for cutting the cost of child benefit: that have been considered by An Bord Snip Nua and the Commission on Taxation. These are: making the benefit taxable, reducing the payment rate for everyone, or means-testing the benefit. Callan and Nolan argue that taxing child benefit has superior distributive properties. David Madden provides detailed feedback in a comment on the post; here is an excerpt:
"Child benefit (or childrens allowance as it used be called) was originally paid via a tax allowance to the main earner in a household (almost always the father)... It was then changed to a direct payment to the mother. The belief was that mothers would be more sensitive to the needs of children and hence in that regard the payment would be better targetted. I did some research on this a few years ago, looking at HBS data to see whether expenditure from child benefit differed from expenditure from general income (UCD Economics WP: 99/26). I found that it was generally more targetted towards children but that this was due more to its labelling effect (as a direct payment labelled as a child benefit) rather than because it was paid to the mother... Any reform (and as I say I don’t disagree with the basic Callan/Nolan argument) should try to retain child benefit as a direct payment. If it becomes too closely integrated into the tax system then the danger is that it will be less effective in fulfilling its role, which is to benefit children."
Other Irish commentary on the economics of child benefit was made on the Cork Economics Blog last October; by Declan Jordan:
"I posted my views on potential options some time ago on this blog – favouring the taxation route as more efficient and equitable approach... However, there is a very straightforward way to make some savings in child benefit and that would be to remove the increase in payment for third and subsequent children. The Annual SWS Statistical Information Report 2008 shows that there are 41,397 children who are the third or subsequent child in their family and for whom €187 per month is paid rather than €150 for the first two children. It is difficult to understand why the third and subsequent children should cost more than the first two. Economies of scale are surely relevant here as well as the concept of ‘hand-me-downs’. Reducing the payment to third and subsequent children to €150 would immediately save €18m annually. Not a significant amount but not to be sneezed at. Reducing subsequent payments to €100 would generate €43m – which is approximately equivalent to a 2% cut in the payment across the board."
Declan Jordan supports the (taxation) approach suggested by Tim Callan and Brian Nolan. In addition, Jordan makes the observation that household economies of scale are totally ignored in the current design of the Irish scheme. In fact, the Irish scheme is designed in such a way that it seems to anticipate diseconomies of scale. This is in stark contrast with the design of the UK scheme. Payments for subsequent children is an issue than could be tackled in the current design of the Irish scheme... before making a decision about the scheme's distributional approach.

Other Irish commentary that is relevant to this debate was produced by Ferdinand von Prondzynski, while he held the presidency of Dublin City University. Ferdinand focused on a critique of universalism; this excerpt summaries the crux of his argument:
"Should social benefits be ‘universal’ (i.e. made available to everyone) or should they be ‘targeted’ (with the resources directed specifically at those most in need of them)? The idea of universal benefits is a product of the development of the welfare state in the period after the Second World War... The major advantage of universal benefits is that they are easy to administer and can be efficiently delivered. The major disadvantage is that they are very expensive, because they are delivered to those who do not need them as much as to those who do.

As society becomes more prosperous and fairer, universal benefits become much more questionable. The major priorities of social policy... should no longer be directed towards transforming society as a whole, but rather to target those pockets in society which have still not caught up... It is, therefore, perhaps now time to discuss whether universal benefits are an efficient way of achieving further progress. Indeed, it could be asked whether they are even a fair way of doing it, since people who are less well off also contribute to the cost of making contributions to those who are wealthy."
The Economist produced a very in-depth piece on the issues that Ferdinand discusses above, back in an edition from May 1999. The piece discusses how the New Labour government set about reducing the extent of universality in the UK. An excerpt is as folows: "The left has traditionally supported universal benefits. Many on the left argue that unless the middle class benefits from the welfare state, it will refuse to pay the taxes to subsidise welfare for the poor... On the other hand, the left is also concerned about beating poverty and reducing inequality. The more state benefits go to everyone, the less generous they are. The more they are directed at the middle classes, the less they will do to redistribute wealth... The politics of getting rid of universal benefits are fraught. But British voters, whatever they tell opinion pollsters, seem to balk at paying more than 40% of their incomes in tax."

There are also academic articles in peer-reviewed journals: addressing a very similar set of issues to that discussed above by The Economist. One example is Besley (Economica, 1989): "Means Testing Versus Universal Provision in Poverty Alleviation Programmes". Besley produces an analytical framework: where universal provision "entails a cost in the form of a leakage of some of the benefit to the non-poor. On the other hand, means-tested programmes may be costly to administer since they require a test of eligibility for claimants. They also impose costs (psychic and pecuniary) on the poor who have to claim, which may deter some of them from claiming."

The point about psychic costs is relevant to the issue of stigma that was raised by Kevin. The Besley paper proposes a trade-off between the costs of means-testing and the leakage in universal provision. What it doesn't suggest though: is a third way: such as the taxation of benefits as recommended by Callan and Nolan; and mooted in the Osborne initiative (as described by the BBC): "declare this fact (high-income) on their self-assessment tax returns, implying they would then face an extra tax charge. (Or)... it might be simpler for HM Revenue & Customs... simply to cross-reference claimants against their tax records."

Finally, I think it is worthwhile drawing attention to the fact that there is already a well-established means-testing scheme in Ireland: the medical card scheme. Anne Nolan of the ESRI notes that: "In Ireland, approximately 30 per cent of the population (medical card patients) are entitled to free GP care, while the remaining 70 per cent (private patients) must pay the full cost. Eligibility for a medical card is primarily decided on the basis of an income means test, but individuals may also be granted a medical card on the basis of age (since July 2001, all over 70s are automatically entitled to a medical card), particular health needs or participation in certain Government-sponsored employment and training schemes."

One could attempt to isolate the sub-sample of households that are eligible for a medical card using the scheme's income means test; and provide child benefit only to those households. However, there is good reason to argue that any household which is eligible for a medical card (for whatever reason the card is authorised): should be in receipt of a child benefit payment. The main point is that the existing distinction of being eligible for a medical card is a possibility for targeting that seems to have been overlooked to date: in considering how child benefit might be targeted towards those who need it most. Of course, there may still be potential for stigma; but it should only arise through a reluctance to take up eligibility for a medical card (which is arguably less likely to occur than a reluctance to claim child benefit).

Addendum: In summary, there are well-developed arguments that universal benefits may not be an efficient way of achieving further progress for the welfare state. From 2013, there will be a clawback of child benefit in the UK: affecting people earning more than £44,000 a year. How this clawback will be achieved is unclear; a self-declaration mechanism has been suggested; aswell as the cross-referencing of claimants against their tax records. What we do know is that there are evidence-based concerns that means-testing of government programs can lead to (at least perceptions of) stigma. However, means-testing is not the only way to achieve a non-universal approach.

Besides self-declaration, and cross-referencing against tax records; there is also the possibility of taxing child benefit (which presumably would also have to involve linking to tax records). This was suggested for the Irish case by Tim Callan and Brian Nolan, in 2009. As a cost-reducing measure, Declan Jordan suggested that there be recognition of household economies of scale; the initiative that Jordan describes could lead to a saving of €43m (which could cover the cost of any wider reform initiative; such as the one suggested by Callan and Nolan).

Finally, it is suggested in this post that providing child benefit on the basis of medical card-eligibility is an alternative to the taxation (of benefit) approach suggested by Callan and Nolan. This could reduce the cost of the current scheme by two thirds (or approximately €1.5 billion); based on a very rough estimate. Approximately 30 per cent of the population hold medical cards; but of course: there may be multiple medical cards per household (which would mean a cost-reduction of 66% is very much an over-estimate).

Postscript: An update is available here.


Ronan Lyons said...

The problem with the medical card option, and indeed with anything that leaves social welfare outside the tax net, is that it further entrenches the borders between the working and the welfare.

If all social welfare payments are made part of taxable income, i.e. not self-assessment or opt-in but rather a bit of joined up thinking between Revenue and Social Protection, that destroys the borders between someone who earns €25,000 through working and someone gifted €25,000 by the State.

Barra said...

Good post. What's your reading of the empirical literature on the effect of child benefit on outcomes, the main motivation behind the huge increases in child benefit being to improve these? Unless the reason is to incentivise people to have childen, and the Iona institute secretly define government policy.

Martin Ryan said...

Ronan, thanks for the feedback.

On whether child benefit could indeed be taxed, I just read this afternoon in the Irish Times that:

"An advisory group established by her (Joan Burton) earlier this year to examine ways of mean-testing or taxing the benefit has concluded in a preliminary indication that taxing the benefit is not possible. Its full report is not due out until March 2012."

I'm looking forward to reading that report in full next year. As far as I am aware, the Commission on Taxation thought that it would have been possible to tax child benefit. I know particular issues can arise though - once one sits down to map out an implementation-strategy.

For now, the preliminary report of Burton's advisory group would seem to leave the medical card option as the only remaining possibility for reform. Of course, this would have to involve a link between the computer systems in the HSE and the systems in the Department of Social Protection.

With respect to logistical IT issues, Joe Carthy, from the UCD School of Computer Science and Informatics, was on NewsTalk radio before lunch-time today: suggesting that it was very much possible to make the systems at Revenue and Social Protection "talk to each other". Carthy suggests that he could set this up easily himself within a month, for a small fee. So "computer says no" should not be trotted out as an excuse in the report due out next March.

In the UK, it is the same body, Revenue and Customs, which "both dishes out child benefit and collects income tax, (so it) could readily identify these families." From The Economist, about a year ago.

Finally, even if child benefit remains outside the system of taxation, there are still ways to make the trade-off being working and welfare stack up so that there is always an incentive to take up a job. When Osborne made his announcement about a clawback in child-benefit last year, he also revealed that the total state benefits one family can claim in future will be capped at about £26,000 per annum. "This will mean that no family on welfare will be better off than one earning an average income from work, the chancellor said." From the BBC.

A cap on annual family benefits here in Ireland might allay some of your concerns.

Martin Ryan said...

Barra, thanks for the feedback.

You raise an interesting point. It's one that I didn't cover in the main post as I was focused on the debate between means-testing and universality; suggestions for a non-universal approach that would not involve means-testing; and other issues, such as household economies of scale.

However, I did read some of the literature that you would be interested in, yesterday. David Madden (from the School of Economics at UCD) has done some relevant research: that I cited in the main post. I didn't mention this conclusion from Madden's paper though:

"...Child benefit may not directly combat child poverty, in the sense that it appears that the extent to which children do relatively better out of child benefit is greater amongst better-off families. Once again, this finding should be interpreted with caution. While children in better off families may do relatively better from child benefit than those in poor families this does not imply that children in poor families do not gain from child benefit, nor that it does not alleviate child poverty in these families. Overall, while the results presented in this paper are relatively tentative, they do suggest that child benefit is successful in that it does help children."

So while it may be the case that child benefit is good for *all* children (to some extent); it seems that children from better-off families benefit more. This can be used as motivation to target child benefit towards children from worse-off families; if one believes that child benefit primarily exists to help those children who are worse-off.

In the current situation in Ireland (where a €3.8 billion adjustment must be made in the upcoming Budget), I think it would be fairest to end the universal provision of child care rather than have a cut in the benefit right across the board.

Another research paper ("Who Benefits from Child Benefit?"), by Blow, Walker and Zhu (2006) suggests that (universal) child benefit may simply finance spending on children that would have otherwise occurred. So we are into the territory of "deadweight loss". The taxpayer spends a lot of money without creating all that much additional child-welfare. Unless the benefit scheme could be targeted, of course.

Martin Ryan said...


Another paper has come to my attention from the empirical literature on the effect of child benefit on outcomes. Last month, the IZA released the following discussion paper: The Effects of a Universal Child Benefit. It's by Libertad González at UPF Barcelona; and an abridged abstract is below.

"I study the impact of a universal child benefit on fertility and family well-being. I exploit the unanticipated introduction of a new, sizeable, unconditional child benefit in Spain in 2007, granted to all mothers giving birth on or after July 1, 2007. The regression discontinuity-type design allows for a credible identification of the causal effects. I find that the benefit did lead to a significant increase in fertility, as intended, part of it coming from an immediate reduction in abortions. On the unintended side, I find that families who received the benefit did not increase their overall expenditure or their consumption of directly child-related goods and services. Instead, eligible mothers stayed out of the labor force significantly longer after giving birth, which in turn led to their children spending less time in formal child care".

As it happens, the Spanish child benefit was removed in May 2010 (in effect for births starting January 2011), as part of broader budget cuts. Of course, what is particularly different about this case is that there was an explicit policy objective to increase fertility. Somebody should forward this paper on to Michael O'Leary.

Barra said...

Thanks for that Martin. Both now on the reading list. I asked as short lit review at the end of this piece ( by Blow & Walker & others seemed to suggest that there was little evidence for any significant effect of income on child outcomes. Of course they weren't looking at specific scheme or transfer, but happened to read your post and that at the same time.

Thanks for the papers.