Simple comparisons overstate differences between Irish and UK work incentives

Comparisons based simply on “top line” figures such as rates of income tax and welfare payments can overstate the differences between work incentives facing the Irish and UK populations. New results using harmonised tax-benefit models for Ireland and the UK show that neither jurisdiction could be regarded as having a work incentive regime which is consistently more favourable to work than the other. These results are based on detailed estimates of the incentives faced by nationally representative samples under the tax and benefit systems prevailing in April 2015.

The study examined first the incentive to be in paid work, as measured by the replacement rate (the income someone would receive if they were not working as a percentage of the income they would receive if they were in work) for those who are unemployed, others not in paid work, and those in employment. On average, replacement rates were broadly similar in the two countries, but there is more variation in the UK – with higher proportions of those out of work in the UK facing very low replacement rates and higher proportions facing replacement rates above 70 per cent, which are particularly damaging to work incentives.

To some extent, these differences can be explained by differences in the family composition of the UK and Irish populations. There is, however, some cross-country variation in the incentives facing different family types. On average, potential first earners in couples with children face weaker incentives to be in full-time work in the UK than in Ireland, while the opposite is true for potential first earners in couples without children. This is partly due to differences in the design of each country’s benefit system: the UK provides more generous out-of-work benefits to couples with children than does Ireland, while the opposite is true for out-of-work couples without children.

The paper also examines the incentive to seek additional earnings (e.g. through longer hours, seeking promotion or a higher paying job). This is measured by the marginal effective tax-cum-benefit withdrawal rate (the METR measures how much of an increase in pay is absorbed in increased tax and/or reductions in welfare benefits). More than 2 out of 5 Irish workers face a marginal effective tax rate greater than 50 per cent, compared to fewer than 1 in 5 in the UK. However, as of April 2015, more UK workers faced marginal effective tax rates in excess of 70 per cent than their Irish counterparts, because of the simultaneous withdrawal of multiple means-tested benefits in the UK. Concerns about the effects these high METRs could have on the work decisions of low-income households were in part responsible for the previous UK government’s decision to replace the main means-tested benefits and tax credits for those of working age with a single means-tested payment, known as Universal Credit which is being introduced over the next few years.

Commenting on the paper, Professor Tim Callan said “Comparisons of tax and welfare systems that rely simply on illustrative cases or headline tax rates can be highly misleading. A comprehensive picture based on nationally representative survey data shows that on average, replacement rates –a key measure of the incentive to be in paid work –are broadly similar in the two countries."