Why Do Incentives To Work Matter?

This post is by PaulL, a regular commentor and occasional contributor.   It is the first post in a series on the financial incentives to work and the impacts of our tax and transfer system on household formation. The index for the full series is here.

Adam Smith in 1776 famously said “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest. We address ourselves not to their humanity but to their self-love, and never talk to them of our own necessities, but of their advantages.”  His point was that in a free market we don’t appeal to the good will of the baker to bake our bread.  They bake bread because they can sell it – they do it because it’s in their interest to do so.

Society benefits when people work.  Many of the things we want in life are produced by other people through their work.  Working also creates social cohesion and gives people a stake in society.  It often leads to a sense of purpose and improved mental health.  Parents working provide a role model to their children and to others in the community.

Having said that, I’m also well aware that It’s called work for a reason.  While we may enjoy our work, who amongst us would choose to spend our time (or as much time) at work if we didn’t get paid for it?  Perhaps we’d instead stay at home and play video games, or buy a Transit van and tour NZ enjoying our incredible country.

The National Party appear to understand incentives.  They are focused on reducing the 39% tax rate at least partly on the grounds that if someone only keeps 60% of the money they earn from an additional hour of work, then they might work less than they otherwise would, take fewer risks, and employ fewer workers.

There is probably some truth to this, although evidence from other countries with much higher top marginal tax rates would suggest it’s not critical.  Of course, many of those countries have a headline top tax rate with large loopholes.  They politically can say “look at how we’re whacking the one percenters” whilst quietly letting them pay far less tax through a variety of deductions and tax shelters (NZ has relatively few of these).

At the lower end of the income scale incentives also matter.  For someone on a benefit moving into a job, it matters how much of the money they earn they get to keep.  If someone is sitting on the sofa playing video games, and we say “hey, how about you get a job”, are we likely to be successful if them getting a job doesn’t increase their income?  If a sole parent looking after kids at home is asked to get a job, will they do that if they know it means time away from their kids, but there won’t be any more income in the household than there was before?  What if them getting a job actually meant lower income in the household?

I would argue that at the lower end incentives matter even more than the top end.  For someone earning $180K per annum, working an extra hour isn’t a massive stretch.  For someone not working at all, working that first hour is a massive change.

National have foreshadowed a policy to help young people into work, largely based around encouraging them to get a job.  If you’re on the left you might interpret that as a punitive programme – we’re going to force people into a job.  If you’re on the right, you might interpret that as an appeal to the young person’s morals – they should get a job, it’s their duty.

If we paraphrase Adam Smith, surely it should be the case that “It is not from the benevolence of the young person that we expect them to work, but from their regard to their own self-interest. We address ourselves not to their humanity but to their self-love, and never talk to them of our own necessities, but of their advantages.”

Any sensible policy should surely encourage people to work because of the sweet, sweet cash that they’ll end up with in their pocket, not through appeals to their better nature, or through attempts to force them into work by implementing sanctions if they don’t.

How much cash would people need to move into work?  Similar to foreign tax systems with very high headline top tax rates, our system has a low headline bottom tax rate, at 14%.  So if I go to work for the minimum wage of $21.20 an hour, I get to keep $18 an hour, right? 

What if I told you, like those headline top tax rates, our system was broken?  The true tax rate facing someone moving off a benefit can be 80% or more, and sometimes, they’re actually worse off from getting a job (or from working an extra hour if they’re already part time). 

This series will argue that we are systematically discouraging work and that, no matter how many case managers we employ at WINZ, we can’t make people do things that make no financial sense for them.  If we want people to work we need to make sure it pays them to do so.