Investigate, using the standard labour supply model, how this change in benefits will affect labour supply decisions for a single mother with two children who is able to find work at £30/hour
The Labour supply model has been used as a method to analyse the availability of labour when compared with a set wage being offered to a certain individual and how at different wages and income levels individuals will either work more or less hours. Individuals are left with a choice between consumption, goods and services they can buy and consume at the expense of money, and leisure time, unpaid hours of the day where the individual can do what they please. However the trade off is not simply just between hours of work and leisure time as people also receive non-wage income, such as interest on savings as well as untaxed benefits from the state. Child benefits used to be a benefit paid to every UK citizen with children regardless of income and wealth until it was changed on the 7th of January 2013. With this change we may expect to see there being disincentives to work around certain annual wages due to there being a possible benefit trap where an individual is better off working less hours, as they will receive more money for it. Or the change could result in the income effect or the substitution effect coming into place.
The change to the child benefit policy that occurred on January 7th 2013 meant that couples or single parents no longer received child benefits for their children if the higher earner of the two earned over £60,000 before tax. This was predicted to affect around 820,000 families in the UK. As soon as the highest earner of the two reaches £50,000 they will lose 1% in tax of the child benefits they would receive for every £100 earned over £50,000. There have been many critics of this new policy as there are marked discrepancies whereby a couple both earning £50,000 with a pre-taxed household income of £100,000 would continue to receive their child benefits whereas another couple where one is a stay at home parent with no wages with the other earning £60,000 although £40,000 less well off than the previous couple before benefits are added would not qualify for child benefits. (Wintour, 2017) The Institute of Fiscal Studies (IFS) has pointed out that the marginal rate of tax for those earning between £50,000 and £60,000 has increased by 11 percentage points for the first child and seven percentage points for the following children, and this could potentially affect the single mother we are investigating as well as roughly 320,000 other individuals who earn in the same income bracket. So from the 40% tax we should expect our single mother to be paying if she worked between 1667 and 2000 hours annually we see a marginal tax rate of 58% if we work off the numbers that the IFS have given. This provides evidence that the income effect will take place, as through the increase in her marginal tax she has less purchasing power than she would have had previously before the policy change hence causing her in theory to work more. (James, 2017)We can show the labour supply response of the mother in the backward bending supply curve of labour in Figure 1 as due to her real wages being reduced through the fact that she is paying a higher marginal rate of tax because of the policy change that she is now willing to work more hours in order to maintain the same level of consumption, so she moves from W2 to W1.
The labour supply model is a mathematic calculation used to depict the trade off for an individual between consumption and leisure time by the use of a budget constraint, the trade-off being equal to the wage rate being offered. The equation used to create the budget constraint that I have used to make Figure 2 and 3 is I (income) = W (wages) x H (hours) the income is then taxed at the following rates, (0% tax up till £8,105, 20% between £8,106 and £42,475 and 40% for £42,476 and above) to give us C (consumption). The mother we are investigating receives an hourly wage rate of £30 and she determines how many hours she works. She has also opted out the government maximum weekly hours, 48 hours, meaning that in our investigation she can work a maximum of 100 hours which we see gains her a maximum possible post tax income of £103,714.6. This gives us our Y intercept and our X intercept comes at 5200, the maximum amount of hours our mother can work a year. The budget constraint in figure 2 shows us the benefit line on the diagram before the policy was introduced. Here we can see that the benefit line is parallel to the budget constraint, being constantly £1,752.40 above the budget constraint meaning that her new Y intersect would now be at £105,467. (BBC, 2013)This is because before January 7th 2013 all people with a child regardless of their wage would receive the child benefit if they have a child, and for the single mother of two she would each week receive £33.70, £20.30 for her first child and £13.40 for her second child. The blue budget constraint, which represents our single mothers earnings after tax, this line, is the same in Figure 2 and Figure 3. We see that on this line two kinks occur. Working from right to left the first kink occurs at (4929.83, 8105) up until £8,105 her income in not taxed and the line has a gradient of 30 but after this tax-free allowance she is then taxed 20% between £8,106 and £42,475. The second kink occurs at (3784.17, 35600.2) this is because £35,600.2 equates to £42,476 before tax. After it has been taxed the kink occurs here because the tax rate is levied further to 40% for all earnings after £42,476 and the gradient of the line switches from being 24 to 18. Figure 4 shows us the benefit received by the mother as a percentage of her income both before and after the policy was introduced. To obtain these numbers I divided the sum of her benefits she received which before 2013 was always £1,752.40 and after 2013 had varying values. I then divided this number by her relative post-tax income plus the benefit received on top and multiplied by 100 to obtain the percentage value.