EMTRs and Household Formation

This post is by PaulL, a regular commentor and occasional contributor.   It is the sixth 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 considers the impact of the tax and transfer system on household formation.  There is a lot of research on this in the USA (example), and it is widely accepted that the US has a “marriage penalty” – that is to say that getting married results in you paying more taxes than if you hadn’t gotten married.  

Why do we care about household formation?  Research shows that households with two parents improve life outcomes for children.  Households with two parents are more likely to have non-benefit income, which is also beneficial for the parents and the children.  People in a stable relationship report higher happiness than those who are single.  In short, stable relationships are a good thing.

How does our tax and transfer system impact formation of stable relationships?  

Consider an example of a solo mother (three children, 2, 4, and 6), and a separated father (has children, but sees them every second weekend).  The father has a job paying $29 per hour, or $60,000 for a 40 hour week.  The mother is benefit supported, with two children under 5 it’s pretty hard to move into paying work as the previous posts have demonstrated.

Prior to these two meeting their respective incomes are $982 after tax and transfers for the father, and $906 after tax and transfers for the mother.  The father is receiving a small amount of accommodation supplement ($36 a week), but no other government benefits.  The mother is receiving a benefit, accommodation supplement and family tax credits.

Imagine these two meet up and start a relationship.  Things get reasonably serious, and they consider moving in together.  What is the impact to the household budget of moving in?

We also need to consider the change in power dynamic too.  The mother previously had her own income from the benefit. She had $606 per week that she controlled the spending of.  If they move in together she is now more dependent on the father for income – the only income she might consider “her own” are the family tax credits and accommodation supplement, less her half the rent, totalling $270.  Note also that the “father” in this case is a father of different children, not children with this partner.

In a long term stable relationship this may be fine – they’re a partnership and it’s OK that one is working and one is not.  But in a new relationship this may be a risky power dynamic.

In short:

• There is a financial disincentive to move in together.  This couple lose $422 per week of income, or a third of their income after accommodation, by moving in together.  This is the opposite of the usual expectation that “two can live cheaper than one,” which would hold absent the government benefit system
• Moving in together also shifts the mother from relying on government support to relying on her new partner for income.  This may be a social disincentive to move in together – it puts the mother’s financial security at risk

I can see why the benefit system works this way – it’s needs based, and when you move in together your needs reduce.  Also, if the benefit system didn’t deliver more income when you live separately, then it would make it financially disadvantageous for a woman to leave an abusive relationship.  

As a country, it seems intuitive that we should be incentivising the formation of stable family relationships.  This is known to improve family outcomes and improve happiness, and it’s a path to move away from benefit dependency, which reduces cost to the taxpayer.  

Our current tax and transfer system does not do this – it makes it hard for a solo parent to enter a new stable relationship.