Working for Families is a mess that can’t be cleaned up

Dr Eric Crampton
7 June, 2022

It’s hard to solve a problem like Working for Families.

The most frustrating thing, for an economist who watches policy, are the policy dollar bills left lying around on sidewalks.

There are so many areas where we could be doing so much better, and the solutions are obvious.

Housing and urban land use are frustrating.

One obvious and fairly simple set of policies would end the housing crisis, ease building materials supply, and restore competition in retail areas like grocery where zoning and consenting currently block entry.


Let councils share in the benefits of urban growth, pull them out of joint-and-several liability for building defects, and let them issue infrastructure debt that is paid off only by ongoing charges on the users of the infrastructure.

Problem solved. Government could do it tomorrow. It would take longer than that for the effects to work their way through. There might be need for a bit of central government guidance for councils until the change in incentives brought about the necessary changes in council cultures.

But the underlying problem would be gone.

Cross-party failure to implement obvious solutions is galling.

Working for Families isn’t like that.

Working for Families has given us a mess that may have no solution. Or at least no solution that doesn’t cause other problems.

The Ministry for Social Development, along with Inland Revenue, the Department of Prime Minister and Cabinet, and Treasury, are reviewing Working for Families.

I can see no way of improving the scheme, just an intractable problem.

What’s the problem?

A family with two kids, either with a single-earner making $60,000, or two earners making $65,000 between them, pay no net tax. The amount they get through Working for Families matches the amount they pay in income tax on their earnings. So they’re on a 0% net tax rate.

Now that might not sound like any kind of problem if you like low taxes.

Low taxes can be excellent.

But the family is not facing a low tax rate on the next dollar earned. Far from it. If it’s a single-earner family, the next dollar earned draws $0.30 in income tax and a $0.27 reduction in the Family Tax Credit.

So while the family pays no net tax, they face a 57% tax rate on the next dollar earned: their Effective Marginal Tax Rate. And we’ll leave to the side additional messes that come with the Accommodation Supplement.

If you’re deciding on hours of work, putting in extra effort to go for promotion, or whether a second earner should pick up a few hours a week in part-time work as the kids get older, the Effective Marginal Tax Rate is going to matter. Getting to keep less than fifty cents on some of those dollars is pretty discouraging. And it can encourage under-the-table work, for those who have that option.

It is worse than a mess. Housing is a mess, but at least there is a solution – governments just do not seem keen on doing what they obviously should be doing.

This one is an intractable mess with no solutions. Making the thing less bad in some aspects necessarily makes it worse in others.

It’s worth reviewing how we got into this.

In the mid-2000s, Helen Clark’s Labour government wanted to improve work uptake among those on benefit with children. It was under some pressure about the number of young single women who were having children while on benefits, who had been born to mothers who had been on benefit themselves. And the government, very rightly, worried about the consequences of long-term dependence.

Shifting from benefit into low-paid work did not provide much advantage for those making the shift, at least in the short term. Being in work is costly: there’s transport, lunches, and child-care to arrange.

When the work is low-paid, it may not seem worth it. Over time, building up skills and experience leads to higher wages that make up for the up-front cost. But it is hard to see that from the starting point.

So the Clark government moved to subsidise early childhood care, to make it easier for single parents to shift into work.

And it sought to improve the return to being in work for those starting out. A larger difference in household incomes for those in lower-paid work and those on benefit would help.

But reducing benefit levels is never particularly attractive. And trying to do it through minimum wage hikes strongly risked hurting those they wished to help: people shifting from benefit into work are risky prospects for employers, and even more so when minimum wages are higher.

So they moved to top up earnings in lower-paid work for those with children through a subsidy linked to family income. Working for Families was born. The American Earned Income Tax Credit scheme may have been something of an inspiration, though New Zealand’s version had important differences. Labour boosted the amount of the subsidy in 2007.

While National had campaigned against Working for Families when it was established, they did not reverse it when elected in 2008.

Reversing it then would have been hard.

Ending it now is effectively unimaginable. A couple each working full-time at the minimum wage, with two kids, receives just over $5,000 in transfer payments. Their budgets, lives, and potentially a mortgage, will have been built around expectations that that payment continues. If each works only part-time and earns only $10,000 per year before tax, they would be receiving $16,000 in transfers through Working for Families.

And that gets us into some iron-law kinds of impossibilities.

High Effective Marginal Tax Rates (EMTRs) as the Family Tax Credit and In Work Tax Credit abate provide disincentives to work.

Want to lower them? Well, that has costs.

If you keep everything else the same and reduce the clawback rates to, say, 15 cents in the dollar instead of 27 cents, the costs of the scheme will blow out. And the scheme will transfer a lot more money to those on far higher earnings. You reduce the EMTR for some workers by 12 cents. But richer families will start getting payments along with an EMTR that is higher by 15 cents.

So that could be a problem if you care about any of programme cost, targeting of assistance to those in most need, or avoiding higher EMTRs at the top.

If you wanted to reduce the clawback rate without increasing the total budget for the scheme, and without providing transfers to higher-income families, there is a way to do that too.

But I do not think you’re going to like it.

If you want a slide to have a shallower slope but to wind up in the same spot, you have to reduce its height.

And the same is true for Working for Families. If you want to reduce the EMTRs without providing greater benefits to higher-income families and increasing the overall budget, you’re going to have to reduce the amount of payment going to those on the lowest incomes.

If you reduced clawback rates without reducing payments to families on the lowest incomes and without increasing the overall budget, you would have to introduce a hard cut-off on payments where the scheme ends.

Instead of slowly eroding down to zero payments as earned incomes increase, the scheme would have a cliff – equivalent to a slide ending while still a metre and a half off the ground. That causes its own set of problems. Rather than get hurt by the fall, people scramble to stay at the edge of the slide.

There are no “This improves everything!” solutions to be had. Only trade-offs.

Payments through the scheme can extend up to families earning $100,000 before tax. Want fewer transfers to families at the top? You’ll have more punitive EMTRs earlier on, or lower payments to those at the bottom, or both, and possibly a horrible cliff.

Want more transfers at the bottom? You’ll have higher programme costs and more transfers to higher-income families, or higher EMTRs across more of the range, and possibly also a horrible cliff.

Want less overall cost? It’ll mean combination of higher EMTRs and less support for families whose mortgages now depend on it and who will be hostages against the change.

Any move you make to improve one aspect of the thing makes other parts of it worse.

There would be measures that could make the whole thing worse though.

Extending the range of the Minimum Family Tax Credit, which tops up earned income at the bottom, while applying a 100% Effective Marginal Tax Rate, would be a pretty bad idea.

Child-poverty campaigners like Susan St John urge that the In-Work Tax Credit, part of Working for Families, be extended to families that are not in work.

The work requirements for the In-Work tax credit were removed in July 2020, when everyone feared a giant Covid recession.

Making the change permanent would be a mistake.

The point of Working for Families was to make sure that there was a real payoff to being in work. Getting rid of the in-work requirement for the tax credit that is specifically called the “In-Work Tax Credit” undoes that.

A dedicated child tax credit could avoid undoing the gap between incomes in work and out of work – but comes at a price and has its own consequent trade-offs.

A 57% Effective Marginal Tax Rate facing families who pay zero percent net tax is a mess. But it does not seem to be the kind of mess that can be cleaned up.

Unlike housing.

Would that governments fixed the problems that can be fixed before putting effort into the intractable ones. Ending the housing shortage and improving supermarket competition could do a lot more good for family budgets than tweaking transfers to middle-income families.

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