EMTR 1: Sole parent, 2 kids, impact of working additional hours

This post is by PaulL, a regular commentor and occasional contributor.   It is the third post in a series on the financial incentives to work and the impacts of our tax and transfer system on household formation.  The index to all posts in the series can be found here.

This post looks at an example household to understand their effective marginal tax rates and their incentives to go to work.  This example is a solo parent that has two children – one between three and five years old, one over five years.  They live in Auckland and have accommodation costs of $300 per week, so they receive an accommodation supplement.

This post is very detailed, as it explains how to interpret the information.  Subsequent posts will provide other examples, but with less detailed walkthrough.

If this household is entirely benefit supported, their weekly before tax income will include:

• $511 per week in Job Seeker benefit (arguably this person might qualify for the sole parent benefit instead), which is taxable
• $129 in accommodation supplement, which is tax free
• $231 in family tax credits – these exceed the tax payable, but are refundable so you can receive more tax refund than you paid in income tax
• They may be eligible for other, more targeted, benefits, those aren’t considered here
• The total weekly income, after tax, will be $792.41
• This is equivalent to a before tax annual income of $49,000 per annum

If this person was to move into work, they will become eligible for a childcare subsidy.  This subsidy depends on the age of the child. You only get subsidy for children that aren’t in school or in the already-provided 20 hours of free early childhood education (for children aged three to five).

All of the allowances have abatement thresholds and abatement rates – as the household’s income increases they lose access to the various entitlements.

Furthermore, when this person goes to work they have additional expenses.  They get childcare subsidy, but they also have to pay for the actual childcare.  The childcare typically costs more than the subsidy, so the household will end up out of pocket.  They will need transport to work (assumed $10 per day), they will need lunch (assumed $10 per day), they will need work-appropriate clothing (assumed $5 per day on average).  A day of work can cost $25 in work expenses, plus whatever incremental childcare costs they have.

The following graph depicts their situation as they increase their hours of work.  This example assumes that they will earn $25 an hour – above minimum wage, but not a long way above minimum wage.

The grey area at the bottom is their income from working. As expected, the amount they earn increases in a straight line as they work more hours.

The yellow area is the job seeker benefit, after tax and after abatement. It reduces at 30 cents in the dollar once you get to $160 of paid income per, and then by 70 cents in the dollar after 11 hours of work a week.  

Accommodation supplement is in blue. This stays the same until the benefit is fully abated at around 37 hours a week.  After that it abates at 25 cents in the dollar for each extra dollar of income.

Family tax credits (working for family) are in green. These start abating at 5 hours of work a week, abated at a rate of 27 cents in the dollar.

Childcare subsidy in dark blue grows as the number of hours worked grows. This household is first eligible for subsidy once working 20 hours a week. ECE is free for the first 20 hours for children between three and five years old. Beyond that point the family receives subsidy, but not as much as the childcare is costing, so the childcare is a net cost to the household.  The subsidy rate drops at 39 hours a week, and again at 58 hours a week, although a household with a sole parent of two young children is probably unlikely to work 58 hours a week.

The top of the area graph shows the total household income over time.  When working zero hours this household has $792 a week of after tax and transfer income.  At 10 hours per week they have $948 a week, an effective $15 per hour in the hand.  At 20 hours per week they have $990 per week, the extra 10 hours of work returned $5 an hour.  At 40 hours per week they have $1,302 income, those extra 20 hours of work return $15.50 per hour.

That analysis considers only the income side.  This household also has expenses from working.

Childcare costs and costs of going to work are the blue line near the bottom.  They have to pay for childcare. The childcare subsidy is included in the income numbers above, but you only get subsidy when you incur actual cost.  They need transport to work, they need lunch and ancillary costs whilst at work, and they need clothing specific to work.  

The dark red line is the net impact on household income of the sole parent going to work, after we account for the childcare costs and other expenses.  

When they are not working their net household income is $792 per week.  Working 10 hours per week, their income after expenses is $918 per week.  From there to 36 hours a week there’s no point in working those extra hours – the household income remains at basically $920-$930 per week.  Beyond 37 hours a week the household income spikes as in-work-tax-credits kick in, but then drop for every extra hour worked beyond that point.  

The detailed spreadsheet calculates the EMTR for each additional hour of work.  If we consider purely income (ignoring expenses of childcare in particular) then the EMTR ranges from 18% at the start through to 83% at around 10 hours per week, and 61% at around 21 hours of work.  At 26 hours of work we drop to 38%, and it stays there till 38 hours of work. There’s a noticeable drop at 38 hours when the rate of childcare subsidy drops from $5.69 per hour to $4.53 per hour.

I also calculated the “disposable income tax rate” – like an EMTR but including the impact of childcare costs as well.  This answers the question of “when you work an extra hour, what percentage of the income is left after you pay for transport and childcare associated with that hour of work”.  The effective “tax” rate on income between 10 hours and 37 hours is 95-98%, and beyond 37 hours you get an income drop.  

What is the conclusion from all this?  

At a detail level:

1. Nobody in their right mind would work 40 hours a week to get $170 more disposable income than they had when they weren’t working at all.  That’s $4 of disposable income for each hour of work.
2. For a sole parent childcare costs are a massive barrier to moving into work.  There is a subsidy, but the subsidy isn’t enough.  Expanding the 20 hours of free ECE to a fully free ECE up to 40 hours might be a good policy option to avoid these abatement rates.  
3. If we want people with children under 3 to work, we need some form of ECE policy in that age bracket

At a macro level: there are problems in the incentives to work provided by our tax and transfer system.  People are somewhat rational, and if we continue to operate a system that doesn’t reward work, then people won’t work.  

A link to the Excel spreadsheet / model used to produce this information is below:

Errata: in writing tomorrow’s post I noted an error in the spreadsheet relating to calculation of childcare subsidy for children between 3 and 5. I’ve updated the graph, the spreadsheet and the word, it doesn’t change the overall thrust of the post.