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By 1998 the share of families headed by Lone Parents was 22%, but this represented 55% of families with children in poverty 1. This was largely attributable to low employment rates among lone parents. The UK had one of the worst lone mother employment rates of OECD countries and in an attempt to encourage these low-income families into work the Labour government undertook both passive and active labour market policy reforms. ! These reforms included extending the New Deal program to over 25s and lone parents, the introduction of the National Minimum Wage (NMW) and the replacement of the Family Credit (FC) with the Working Family Tax Credit (WFTC). We will look at the incentives the WFTC was designed to create for all those eligible through a model of labour supply, review the empirical literature to nd the true effect of the reform on both participation and hours, as well as considering other effects it may have induced, and take a critical look at the techniques used in the estimation process. ! The WFTC was phased in to replace the FC in October 1999, it had the same basic design but was more generous than its predecessor. Both required recipients to work for a minimum of 16 hours per week to be eligible for the credit and withdrew the credit at a taper rate after a threshold of earnings was reached. The WFTC, however, gave higher credits, especially to those with younger children and allowed a family to earn more (90 instead of 70) before credits were withdrawn, the taper rate of withdrawl was also lowered (70% to 55%). Formal childcare support was increased, under the FC the maximum support was 60 (100) for one (two) child families, but under the WFTC the support was increased to a 70% subsidy of up to 100 (150), this was conditional in two parent households on both parents working more than the 16 hour threshold. Instead of being paid directly to the recipients the credit was paid through employers via wages.

Tanveer - cut

! ! Figure 2.1 shows the how the WFTC was universally higher than the FC at all points past the 16 hour threshold. The increased generosity of the WFTC was evident as government expenditure on in-work credits rose from 2.68bn in 1998-99 to 4.81bn in 2000-012 with the average recipient seeing credit increase 20% but a quarter of mothers

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experiencing a real rise of 50%.3 The aim was to increase employment and reduce poverty and although higher employment would reduce the amount of claimants of Job Seekers Allowance (JSA) and Income Support, the reform was never intended to be cost neutral. To increase employment extra incentives to work must make the unemployment trap less attractive and to decrease poverty we would expect to observe positive incentives on the intensive margin. To evaluate the effectiveness of the reform in achieving these two key goals we can look at how the budget constraint of a recipient changed and use labour supply theory to investigate the different incentives created. ! The reform consisted of two main changes to the budget constraint which affected individuals incentives to work differently, the lowering of the taper rate, and the increased generosity of the credit. ! The larger credit amount implies that any eligible adult either out of work of working less than 16 hours a week will observe a larger negative marginal effective tax rate at the 16 hour threshold. This higher potential earnings will create a substitution effect towards work and the desired positive effect on the extensive margin will be strong. This is especially true for both lone mothers and married women with children, whos labour supply is much more elastic than their male counterparts. ! However, due to the increase in the credit we see less desirable effects on the intensive margin. Any individual working more than the 16 hour threshold will experience an income effect away from work as they receive the higher credit, so can maintain prereform utility levels by working less.

New header - theory 2.1 Theory look at labour supply and tanveers notes

! Labour supply theory states that the level of supply of labour is dictated not by total wage but by the marginal wage rate. The lowering of the taper rate was designed to reduce the high marginal effective tax rates (METR) experienced when the withdrawl of benets combines with eligibility for national insurance contributions and income tax. Those who previously received the FC see their METR decrease and experience a substitution effect towards work, though the increased income will lead to an income effect away. Fig 2.2 shows us the effect of only a taper rate reduction, with an individual at ha increasing hours to hb so the substitution effect outweighs the income effect. In reality the maximum credit amount and the threshold for the beginning of withdrawl increased, making the income effect larger than shown. The incentives on the intensive margin are positive from a taper rate increase, but when we consider the changes as a whole, negative incentives are likely to exist.

TAPER DIAG ! The lowered taper means that the credit reaches to higher income levels, this implies that there is a set of individuals not previously eligible for the FC who will now be towards the end of the WFTC taper, depicted in Fig 2.2 by individual hA. They receive a windfall of benets and due to the taper of the credit they now face a much higher METR of 70% (55% WFTC withdrawl & 33% NI/IT) rather than the 33% (NI/IT) pre-reform, experiencing both income and substitution effects away from work. This large shift from hA to hB is a worrying poverty trap created by the reform that we will investigate empirically in more detail. NEED TO TALK COUPLES

Dont evaluate theory yet

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confusing Dont evaluate yet

Look at tanveers and lsupply notes for elaboration

! From this look at labour supply theory we can see that there is a denite positive result on the extensive margin but no clear incentive to increase hours past the threshold. This is a denite problem with the WFTC reform and is a key reason for the coalition governments introduction of new plans for a Universal Credit. To assess how the population reacted in both participation and hours we can look at the relevant empirical literature.

New section literature

Did - cant separate from the jsa and income support for example

Reference the canadian experiment

! There are a range of studies looking at the effect of the WFTC reform, the majority use a difference-in-difference approach (DiD), though Brewer et al, 2005 use a structural model of labour supply to obtain their estimates. The DiD methodology uses the reform as a natural experiment, giving us the change in probability of outcome for the average individual. By comparing the marginal effect on the average treatment individual with the outcomes of the control group DiD removes any change in probability attributable to other factors to isolate the impact of the reform. This requires that the treatment and control group are identical in every aspect other than eligibility for the reform, a perfect control groups outcomes follow the same trend as the treatment group over time and are affected equally by any macro shocks or policy changes apart from the WFTC. ! As this is a natural experiment we do not have the benet of an identical control group, the most similar section of the population must be used for comparison. The control group of single childless women is used for lone mothers, they are not eligible for the WFTC, but are expected to have the closest characteristics to the treatment group, such as elasticity of labour supply. This would be the case if children were allocated randomly, however, the presence of children is likely to be an indicator of other characteristics of the

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woman. Lone mothers are more likely to have a lower level of education, be non-white, live in social housing and crucially, are less likely to be in employment.

Maybe talk low ed control

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! The difference in employment levels is large, and was one of the key motivations for the reform. The level of employment for single childless women has been relatively static, averaging at 77% between 1996 and 2002 4. The level of lone mothers in employment over this period has been following an upwards trend, rising towards the control group level by 8ppts. The convergence can be seen to begin before the introduction of the reform in g 2.3 and may not be solely attributable to the WFTC, in the empirical literature there is no consensus of how this trend should be accounted for. Blundell, Brewer and Shephard (2005) (BBS ) assume the convergence was temporary and would not have continued after 1998, Francesconi and Van der Klauw (2004) (FK) attribute the rise to an anticipation effect before the reform, but this has come under criticism, and Gregg and Harkness (2003) (GH) assume that the convergence would have continued. If GH are correct then all other studies estimates will be biased upwards. ! The government implemented several labour market policies around the time of the introduction of the WFTC: The New Deal was extended to Lone Parents and Over-25s, Income tax was cut from 23% to 22%, the primary National Insurance contribution threshold was increased, mortgage interest rate subsidies were abolished, in 2001 the married couple allowance was replaced by the Child Tax Credit, Income Support and JSA were increased, the NMW was introduced and in April 2002 a lump sum was paid to low income families with young children. Policy changes in the same period affecting the outcomes of treatment and control groups differently can bias DiD estimates as the effect of the WFTC cannot be isolated. ! The NMW was introduced in April 1999, we would expect it to have a positive effect on the extensive margin, as the gap between out-of-work and in-work income increased, but it may also reduce demand for low skill labour. If the impact of the NMW was still being felt by October 1999 then it will have changed estimates of our treatment and control, but all of the impact of this wage oor was felt in the two months after introduction5, and it is not thought that it affected either treatment or control differently. ! The increase in Income Support and JSA increased the attractiveness of the unemployment trap, raising out of work income. Since we observed lone mother
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Make note that table values are MEs

employment rates to be considerably lower than the control groups, we can say that the change in out-of-work benets will have had a greater effect on our treatment group. Brewer et al estimate that this could have lead to an underestimation of the reforms effect of 2ppts. ! The extension of the New Deal program was not universal, lone parents and over 25s had to fulll very different requirements. The impact of the New Deal was felt on job entry, which is where research has found that the WFTC effect was weakest. The program for lone parents consisted of voluntary work focussed interviews and aided job search. It was a successful initiative, with 52% of participants nding work within 6 months, though the impact on employment was expected to take time to show. The program for over 25s consisted of forced subsidized job placements, education and training, so we would expect different results of this initiative for our treatment and control. ! The studies deal with these problems in different ways, GH and BBS acknowledge that their treatment variable will encompass changes from all the reforms over the time period. FK doesnt remove the effect of the other policies but does not state how this will affect estimates and Leigh uses a very small time period, where the WFTC was the most prominent reform, this does not allow time for individuals to fully change their behaviour and subsequently his estimates are particular small and insignicant. ! ! The wealth of literature on the WFTC reform all looks at slightly different aspects of its impact. GH, FK, BBS, BDSS and Leigh (L) give us good estimates of the impact on the extensive margin whereas BDSS, Gregg, Harkness and Smith and Blundell Brewer and Francesconi undertake a more extensive analysis of the impact on the intensive margin. To evaluate the impact of the reform in both these areas we will look at these studies specically. ! Our look at labour supply implied that we should see strong positive results on the extensive margin, in table 2.1 we can see that this is the case. Both GH and FK estimates a reassuringly similar, large effect on employment over 16 hours. Any individuals previously working less than the threshold will experience strong incentives to increase hours, Blundell, Brewer and Francesconi reported as much as a 6 hour average rise. These movers will not be accounted for in a model measuring participation as the dummy dependent variable of employment will not change. This explains why the participation estimates are lower, but they do show a strong movement into work. We would expect GH to have the lowest estimates, as they accounted for the continuing trend of convergence, yet they estimate a higher treatment effect than BBS, although BBS look at lone mothers whilst the other studies look at lone parents in general. There is agreement of a large and signicant positive increase in employment for lone mothers due to the reform, however, the effect on couples is less clear.
Table 2.1: Key Findings of Labour Market Outcomes of Lone Parents Participation 3.6 3.7 3.66 5.11 5.2 by 1999 by 1998 (anticipation) LFS FRS by 2000 by 2002 Employment>16 7.2 7 4 Employment>30 9 3.5

BBS BDSS GH FK

Different terminology

! BBS nd very different results for couples when comparing the LFS and the FRS the FRS results are greater in magnitude and standard error, the smaller sample size is blamed for this difference. BBSs estimates show an interesting feature, when the other partner in the couple is working there is a negative treatment effect, this can be explained when the intricacies of the credit are taken into account. Since family income is aggregated, it is likely that with both partners working the family will be on the taper rate facing both National Insurance and Income Tax payments, the second worker faces a METR of at least 70%. Due to this high rate a substitution effect away from work combined with an income effect generated by the increased credit will act as a disincentive for the second partner to work, they may even experience a higher non working income. BBS nd that for men, when the mother is working, the reform led to a 1ppt drop in employment. BDSS found that by 2002 the reform reduced females in couples employment by 0.57ppt. Although this decrease is small in comparison to the percentage point increases for lone parents in the population it is important to note that the proportion of couples with children in the UK outweighs lone parents *****. As expected in couples where the partner is not working incentives are the same as for an individual and we see a positive response. !
Table 2.2: Key Findings of Labour Market Outcomes of Parents in Couples Participation BDSS by 2000 by 2002 Mothers -0.32 -0.57 Ptnr Not Working 2.6 (4.3) Ptnr Working not sig Fathers 0.46 0.75 Ptnr Not Working 0.5(1.5) Ptnr Working -1(-1.8)

BBS L

LFS (FRS)

Employment>16 1.6 (10%)

Employment>30 2.9 (10%)

How did they change employment Then talk hours Then how did they change hours