There is a common argument that scarce resources should primarily be directed towards those in need. Providing transfers to the affluent may be perceived as a misallocation of resources that should rightfully benefit families requiring assistance. For example, providing child benefits to higher-income households might not be advisable. To prevent the dispersion of transfers to higher-income families, the prevailing stance is that mechanisms like child benefits should be aimed at families genuinely in need of support. This perspective aligns with views expressed by institutions such as the World Bank, the Organisation for Economic Co-operation and Development (OECD), and the European Commission.
An evident approach to direct transfers is by means-testing them. For example, the Australian Family Tax Benefit is subjected to income testing and is linked to the Australian income tax system. Other countries also employ income testing for child benefits. In 2013, the United Kingdom introduced the High Income Child Benefit Charge, which gradually reduces child benefits for high income levels.
In an article accepted in the Australian Economic Review, together with Ray Rees, we discuss universal or targeted transfers in terms of the design of the child benefit in Norway.
One key takeaway from our article is that, before implementing a means-tested scheme, an alternative worth considering is a universal child benefit program funded through an increase in general income taxes. If the concern is about inefficiently allocating resources to high-income families, why not make the transfer universal and instead raise taxes on higher income brackets? This approach, apart from distributing some costs to families without children, effectively diminishes the assistance to higher-income families.
Norwegian family policy
Norway is a country with an active family policy oriented towards enabling families to balance child-rearing and a robust connection to the labour market for both genders, known as the dual-earner model. This commitment to fostering labour market participation among both genders is also evident in the personal income tax system, where taxation is rooted in individual income rather than household income.
Over the past two decades, policies have concentrated on enhancing access to formal childcare. Consequently, all families with children older than one are now ensured access to a slot at a childcare centre at subsidised rates. Parental fees encompass roughly 14 per cent of the actual costs for children under three and approximately 25 per cent for children aged three to five.
However, not all elements of the support system can be considered as promoting the dual-earner family model. A cash-for-care support is extended to parents of children aged between one and two who do not use subsidised care at childcare centres. This scheme is contentious, as it has been seen as a policy to move parents (mothers) back to home care. But, it has been in operation since 1998.
Norway also maintains a relatively modest child benefit support program for children under 18 years of age. To fund the substantial expansion of subsidised childcare services, policymakers have kept the child benefit nominally frozen from 1996 to 2018. Consequently, the economic impact of the child benefit has diminished. While the benefit per child constituted nearly 4 percent of the median household income for families with children in 1996, it only amounted to 1.5 percent in 2019.
Due in part to its diminishing impact over time, means-testing has been under discussion as a way of using scarce resources more efficiently. Against this backdrop, our paper explores two primary alternatives to the current child benefit system: either increasing child benefit support while reducing the number of recipients through means-testing based on household income, or increasing the (universal) transfer and covering the additional costs by increasing the general labour income tax rate. Thus, a key emphasis of our article is to highlight the latter policy option as an alternative to means-testing.
We use a detailed tax-benefit model for Norway and estimate a structural labour supply model to compare the two alternatives.
Means-testing or higher tax?
Our findings highlight the drawbacks of means-testing child benefits based on household income. We ascertain that parents within the middle of the income distribution, in particular, encounter the most pronounced disincentives to work. The reduction in child benefit triggers higher effective marginal tax rates, especially in the middle of the parental income distribution where the support is phased out. While both alternatives yield similar in child poverty, our simulation results show that the means-testing scheme reduces overall labour supply more than the tax-financed universal child benefit scheme, and it exerts a more substantial strain on the government budget.
This underscores a prevalent trade-off inherent in means-testing. The exclusion of affluent individuals from receiving support bears a cost in the form of diminished labour supply incentives, notably impacting households in the middle of the income distribution due to high marginal tax rates. Particularly when the labour supply elasticity of females surpasses that of males, a substantial portion of this response can be attributed to mothers reducing their working hours. Our investigation reveals that the tax-financed universal child benefit scheme incurs a lower cost in terms of reduced labour supply compared to the means-testing scheme, while also redistributing income more extensively. All factors considered with the alternatives examined, a universal scheme emerges as more favourable compared to a means-tested one.
In conclusion, we advocate for an alternative approach: rather than implementing a complex administrative means-testing procedure, policymakers should contemplate maintaining the child benefit in a universal manner. If concerns persist about an excessive allocation of support to high-income families, an apparent solution lies in raising taxes at higher income levels.
How silly. Why not just be logical and split income between family members for tax purposes as in a quotient system? Why incur the costs and excess burdens of tax financed transfers when taxpayers are usually willing to transfer income themselves? It’s what spouses and parents do every day.
You can then have dollar for dollar means tested income supplements for those whose incomes fall below the pooled family tax-free thresholds.
I should add “Been there, done that”
Australia abolished “ability to pay” deductions for children and converted them to non means tested family allowances.
Theses then became means tested notwithstanding they were increased to compensate for GST.
It was all a Treasury “bait and switch” exercise.
Then came massive subsidies for paid external child care – but nothing for families doing their own or informal care.
It’s called a neutral tax policy???
Anyway, shares in child care centres have been profitable!