In 2013 changes in child benefits came into effect in the UK. In particular, child benefit was gradually withdrawn from individuals earning over £50,000 a year and completely withdrawn for individuals earning more than £60,000 a year. 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. Assume that she would opt-out of maximum working time regulation in case this becomes relevant. Finally, the measure of income used in the actual calculation is “adjusted net income”, which is equal to gross income minus pension contributions and several other things. For this essay assume that all of these are zero, i.e. the relevant income is simply the individual’s salary before income tax.
In January 2013 the government introduced a child benefits policy which reduced the income for a person with an individual’s income of over £50,000, and either they or their partner receives Child Benefit. The amount of the charge will depend on how much that person's individual income exceeds £50,000. Where a person has an income between £50,000 and £60,000, the charge applied to their income tax will be 1% of their Child Benefit for every £100 of income between £50,000 and £60,000. The income tax charge will never be more than the amount of Child Benefit they receive. Where a person has an income of over £60,000 the charge will be equal to the full amount of their Child Benefit so they are no better off for receiving the benefit. The current rate for child benefits it £20.30 for the eldest child and £13.40 for any additional child. For example, if the mother has an income of £55,000 and receives Child Benefit for 2 children of £1752.40 for a whole year (£20.30+ £13.40 multiplied by 52), the charge will be 50% (£55,000- £50,000 divided by 100) of the Child Benefit which is £876.20. If, however, the mother has an income of £70,000 the charge will be £1,752, which is the full amount of the child benefit received. In this essay I will work out how these changes will effect labour supply decisions, using the standard labour supply model. I will use an example of a single mother with two children who is able to find work at thirty pounds per hour.
The labour supply model states that consumption is equal to the hourly wage (w) multiplied by the hours of work (h), plus the non-labour income (V). We assume that the total hours of work are equal to the total hours in a year (T) minus the hours spent on leisure in a year (L). Therefore C= w*(T-L) + V
For the example given without income tax or any child benefits included, the hourly wage is 30. The amount of hours in a year (T) is 3000 if we assume the maximum amount of hours she can work in a year is 3000 and the time spent on leisure (L) is variable. We also assume that non-labour income (V) is zero. Therefore C= 30*(3000-L). When drawn this gives a straight line that intercepts the x-axis at 3,000 and the y-axis at 90,000. This means that the maximum amount of hours the mother can use for leisure/work is 3000, and the maximum consumption per year for the woman (excluding taxes and benefits) is £90,000. The slope gives us the trade-off between work and leisure. It shows us how much consumption would be given up for an extra hour of leisure. It therefore also shows us how much extra consumption would be earned with an extra hour of work (an hour less of leisure). This is also known as the wage-rate. In the case of the mother’s budget constraint, the gradient is 90,000 divided by 3,000 which is 30. This is the wage rate that we are told she earns, hence proving that the trade off between work and leisure and the gradient of the budget constraint does give us the wage rate the mother earns. The Current system in the UK states that the personal allowance (no income tax) is £7,475. There is a 20% tax on the first...