Analysis of the Effects of Benefits to Families with Children on Poverty and Work Incentives
This article gives an overview of the research project “The effects of family benefits and financing of early childhood education and care”, which was initiated by the Ministry of Social Affairs and the Ministry of Education and Science, and was carried out by Praxis Center for Policy Studies. The research was supported by the Government Office’s Fund of Wise Decisions and the European Social Fund.
The purpose of the study was to conduct a comparative quantitative analysis of family policy instruments in order to find policy measures that most effectively reduce poverty among children and at the same time do not discourage the labour supply of parents. The study focused on cash benefits and subsidized child care services. The microsimulation model EUROMOD with data from the Estonian Social Survey 2011 was used to simulate the impact of various policy changes on the absolute and relative poverty measures, budgetary expenditures and marginal effective tax rates for the year 2015. The study ranks policy changes according to their cost-effectiveness in poverty reduction and impact on work incentives. The results of the study were used as an input for the government’s green paper on family benefits and services.
The study highlights that Estonian social policy targets various poverty rates and applies different income thresholds for means-tested benefits. Different income thresholds apply slightly different methods to find households’ equivalised incomes. Hence there is no direct match between the targets and instruments of social policy.
The study included about a hundred different hypothetical policy simulations and analysed their effect on government budget and poverty. The most cost-effective policy measures to reduce absolute poverty among children were changes in subsistence benefits; either additional top-ups for families with children or increasing child’s weight in the formula of subsistence benefits. This is followed by an increase in means-tested family benefits. About 90% of additional expenditures that occur due to these policy measures go to families with children below absolute poverty risk threshold (125% of absolute poverty line). Increase in benefits for single-parent households with means-testing is also cost-effective – about 60% of the benefits go to households below absolute poverty risk threshold.
The impact of benefits on labour supply incentives was measured by marginal effective tax rates (METR), which show how much of additionally earned gross wage is taxed away with a combination of increased taxes and reduced social benefits. In Estonia, negative labour supply incentives for low-wage earners arise mainly from subsistence benefits and means-tested family benefits. It means that additional increases of either subsistence benefits or means-tested family benefits would reduce labour supply incentives for certain income range even more. On the other hand increasing universal child benefits would not have such effect on labour supply.