Designing fair and efficient child benefits

In the new Spring Budget, the Chancellor of the Exchequer Jeremy Hunt announced changes to child benefits in the UK. The changes imply higher child benefits for households in certain income groups and potentially a move towards linking child benefits to household rather than individual income. Different views about the fair priority in providing benefits to smaller versus larger households may imply different designs of child benefits, but there is also a trade-off between a fair system, administrative cost, and work incentives.

Child benefits in the UK

Currently, child benefits in the UK amount to £24 per week for the first child and £15.90 for additional children. Only one of the parents can claim the child benefit. If either partner earns more than £50,000 a year, child benefits are tapered out, and at £60,000 no child benefits are paid out (the High Income Child Benefit Charge).

One concern about the system has been a potential unfairness in its treatment of single parents and couples with a single earner. Since the threshold is based on the earnings of the highest earner in the couple, this means that a single parent’s child benefits are tapered out at the same individual income as for the highest earner in a couple. Hence, a couple where both earn almost £50,000 such that they earn almost £100,000 in total receives a full child benefit, whereas a single parent earning £60,000 receives no child benefit. 

The reform announced by the Chancellor is to increase the threshold for the tapering out of child benefits to £60,000 such that no net child benefits are received when the highest earner has an income above £80,000. This reduces the high marginal tax rates for parents earning between £50,000 to £60,000 but increases marginal tax rates for those earning between £60,000 and £80,000. The latter may be a smaller group, but reduced work incentives of higher earners may have larger fiscal costs.

The Chancellor also presented plans to reform the system by basing the tapering out on household rather than individual income. One reading of this is that single and couple households with children earning the same total household income would receive the same child benefits. 

Fairness and household size

When considering fair benefits and household size, the first factor to account for is that in larger households, household income must be shared among more people. The second factor is that larger households are more “efficient” in transforming income into consumption due to their larger scale*.  A two-person household can share a house, a car, and other goods, whereas a single household needs more income per person to consume the same quality of goods. If a couple earns £100,000 and the single person earns £50,000, they have the same per person income, but the couple has higher consumption (due to being more efficient). If instead the couple earns £90,000 in total whereas the single earns £60,000, they may have a similar level of consumption.

In a working paper with Morten Håvarstein and Paolo Piacquadio, Equity and Efficiency When Needs Differ, we investigate two different views about fairness in providing benefits to households of different size. 

The first view is based on comparing benefits in terms of their contribution to household income, such that when households of different size have the same household consumption per member, the preference is to provide the same benefits to both groups. Hence, if the couple earns £90,000 in total whereas the single person earns £60,000, there is no ground for different benefits as both households receive the same consumption per person. This view allows the single household to be compensated for having larger needs per unit of income.

The other view is based on comparing benefits in terms of their contribution to household consumption, such that when households of different size have the same household consumption per member, there is still ground for larger benefits to the larger households because they are more efficient at transforming income into consumption. On this view, if a couple earns £90,000 and the single person earns £60,000, providing lower benefits for the single and larger benefits to the couple is considered better than providing the same benefits to both groups. This view favours the couple reaping gains from being a more efficient household unit than the single unit. 

One interpretation of the reform announced in the Budget to use household income as a basis for tapering out of child benefits could be that it is a move in the direction from a more consumption-based view of fairness to a more income-based view of fairness. The current system implies that if a single parent with one child earns the same per person (household income divided by two) as the couple with one child (household income divided by three), the single parent may receive lower child benefits than the couple. This is despite the couple with one child having higher average consumption than the single parent with one child**.  The consumption-based view of fairness can support this policy, whereas the income-based view of fairness would prioritise benefits to the single parent household. If the new threshold is to be based on total household income, certain single parents with children will receive higher benefits relative to certain couples with children at the same average household income. This approach aligns with the income-based view of fairness.

Individual and household income

Another relevant factor is the difference between providing benefits based on household income and individual income. Even though household income better represents variations in the needs of different households, any tapering out of benefits based on household income is typically detrimental to work incentives for the second earner. This is because having a high-earning spouse increases the second earner’s marginal tax rate on their individual income when accounting for the tapering out of benefits.

Another issue with using household income is that the information is not currently collected by HMRC. There may also be legal challenges about how to define households and household income. An alternative solution to improve the situation of single parents could be to introduce a separate threshold for single parents. This would require individuals to report on their tax return whether they are single parents. To also improve the situation of single-earner couples, a similar policy could apply to them. While still providing more tapering out of child benefits for couples with large individual income differences, such an approach may resolve some issues around the fairness in the provision of child benefits to households with larger needs at a lower administrative cost to the tax authority than a system based on household income.

In conclusion, there are different views about the fair provision of benefits for smaller versus larger households and which of these views is adopted matters for the design of child benefits. In addition, there is a trade-off between accounting for differences in needs across households of different size in the design of child benefits and having a system with low administrative costs that provides work incentives for second earners. 

*This is the reason why comparisons across different size households often employ equivalence scales to transform household income into units of consumption or equivalent income.

** When the single parent with one child earns £60,000 the average household income including children is £30,000. When the couple with one child earns £90,000 in total, the average household income including children is £30,000. In this case, only the couple may receive child benefits under the current system (if their individual incomes are similar). The couple has a higher average consumption before child benefits because they are more people and have the same average income per person.