What are the hidden effects of tax credits?

UK tax credits are benefits first introduced in 1999 to help low-paid families through topping up their wages with the aims of ‘making work pay’ and reducing poverty, although they also cover non-working families with children. Recently the Chancellor of the Exchequer proposed cutting the annual tax credit budget, which would have reduced the average annual tax credits and benefits claim of working households by around £750 per year. After being rejected by the House of Lords, the proposed changes have now been abolished. Rightly, public debate has been directed towards the immediate effects of the cuts on poverty and household incomes. But tax credit programmes can also create and change the incentives associated with lifestyle choices and behaviours in a number of socio-economic domains that also have implications for the wellbeing of recipients and their children.

Evidence shows that in many cases UK tax credits helped individuals into work, which raised the income and consumption of poor households. However, it may be that this impacts the decision to have children, and it will also affect how much time parents have available to spend with their children. Already, we can see that the incentives created by tax credits may lead to a chain of events that are complicated, and enter corners of people’s lives that may have been unintended.

Whilst tax credits have often been portrayed as a brainchild of the last Labour government in the UK, a number of other Western countries, including the United States, Canada, New Zealand, France, and Belgium successfully operate their own versions of the programmes. Academics have thought carefully about the ways in which tax credit programmes may change incentives, and how the wellbeing of recipient families and their children are affected. So what are some of the less obvious potential impacts of tax credit changes that could be of public concern?

Higher birth-rates: Could tax credits programmes encourage recipients to have more children, or as one peer claimed in the previous parliament “encourage the poor to breed?” Whilst it is true that tax credit programmes would lower the price of having an additional child and therefore increase the ‘demand for children’, there are also effects that operate in the other direction. For example, when having an additional child, women induced into employment by tax credits now have more to lose in terms of foregone earnings. What does the UK evidence tell us about these effects? Some studies have found that work conditions have raised the fertility of certain subgroups of the population, whilst others have found the opposite for different subgroups. Overall, the picture is complicated and it is not possible to conclude that tax credit programmes universally encourage or discourage families to have more children.

Increase in children’s scores on academic tests: One study found that children in low- to middle-income families who benefitted most from expansions of US tax credits in the late-1980s and mid-1990s saw improvements in maths and reading scores, relative to higher-income families. Other researchers similarly found that increases in family income generated by differences in child tax benefit rules across Canadian provinces lead to improvements in educational achievement. In so far as this raises the future productivity and wages of disadvantaged children, the programme should foster economic growth in the countries concerned.

Low income families become more like middle income families in their expenditure patterns: Gregg et. al (2006) analysed how household spending patterns changed following the introduction of UK tax credits (and other anti-poverty programmes) in 1999. They find that low-income families with children increased their spending on children’s clothing and footwear, fruit and vegetables, and books. Perhaps more surprising is that their evidence shows that low income families reduced spending on alcohol and tobacco, and so became more like middle income families. It is not clear why this should be the case, but it could be due to a decrease in stress given their improved financial position.

Negative effects of family break-up on mothers and children are cushioned: Since the introduction of UK tax credits, there is evidence of substantial beneficial effects for adolescent children growing up in lone parent families, showing improvements in measures of self-esteem, unhappiness scores, truanting measures, smoking, and planning to leave school at age 16.

Determining the influence each spouse has in family decision making: Because a household is composed of various individuals, conflicts of interest arise. One recent UK paper finds that when tax credits were paid to women instead of men, the composition of household spending changed in a way that favoured women and children over men.

While the Government has been interested in cutting spending on tax credits to reduce the budget deficit and much of the public discussion has focused on the direct effects on household incomes, there is likely to be a complex set of other behavioural changes. As many of these relate to the well-being of children and their future productivity, they deserve serious discussion.

Featured image credit: British Coins by William Warby. CC-BY-2.0 via Flickr.