Getting behind the facts – Marginal Effective Tax Rates (METRs), Child Poverty and Income Inequality

Much has been made by both the current and previous Government about how to tackle child poverty (note the much talked about child poverty targets for example). Broadly speaking there are two ways in which this can be done. Both methods predictably centre on increasing the post tax income of a family, the first being through making changes to the benefits and tax credits system and the second being through doing more to incentivise work. In focusing on the latter, CARE has pointed out for a number of years that the Marginal Effective Tax Rates faced by working families (particularly married couples with one earner) is an issue which must be addressed. Indeed, as the graph below shows, this issue is particularly pertinent in the UK, where the problem is particularly pronounced for the very poorest in society.  As such, in 2010 (the latest year for which data is available) UK households were on average facing METRs that were only beaten by Slovakia[1].

For the first time, this new research combines the average METR faced by four different families at 50% average wage; single people without dependants, one earner married couples with two children, lone parents with two children and married couples without dependants. Whilst there is obvious value in doing this, it is worth pointing out that due to differing size of the respective households, where each of these households lie in the income distribution would vary significantly.

For now however, it is important to put these findings into some sort of context. Based on these figures, the UK worker either entering work or increasing their working hours would only take home about 35 pence of every 1 pound earned due to  a reduction in received benefits and an increase in income tax and national insurance. Both the Government and anti-poverty campaigners need to think long and hard about how to effectively combine a system where work is both financially rewarding for the very poorest in society and where benefits are not stripped away so quickly as to make the prospect of work daunting.

Yet this isn’t quite the full story. What about when we add child poverty rates[2] and income inequality into the mix, how does this affect the overall picture? Correlation doesn’t always mean causation, and a lack of correlation doesn’t necessarily mean an absence of causation, but it is interesting to note that the countries with the lowest METRs do not necessarily have the lowest child poverty rates. Indeed, as the graph below shows, there appears to be little correlation between the two.

What are we to conclude then? That the METR has no impact on the child poverty rate of a nation whatsoever? Not exactly. As an intriguing 2006 Joseph Rowntree foundation report has pointed out, incentives to work may well have a bearing on reducing child poverty[3]. Furthermore, work done by the OECD tells us that efforts to boost work incentives for the poorest families would be particularly effective in the UK.[4] Yet both pieces of research mentioned above argue that other things as well as a METR faced by a particular group of the population also have a part to play in a nation’s child poverty rate – the benefits and tax credits system for example. Hence, it is arguably not sufficient for the Government to concentrate all their attention on the METRs faced by the poorest in society, although this is clearly a factor that needs to be addressed.

Interestingly, something that does have a greater (although by no means perfect) correlation with child poverty is income inequality[5] (expressed by the Gini coefficient).  See the graph below.[6]

So, where does this leave us? 

First, there will always have to be a trade off between work incentives and benefits, both of which must exist in some form in any national economy. The real dilemma comes in deciding where to draw this line. Second, although METRs are not the be all and end all in tackling child poverty, they certainly play a part and this is why the UK’s incredibly high METRs faced by those on very low incomes should concern policy makers. This goes hand in hand with the third and final big issue, namely that if the UK Government is serious about getting to grips with child poverty then it should investigate ways in which the gap between the richest and the poorest can be reduced.


[1] Based on calculations made from Taxing Wages, 2011, OECD, p.109-142 (see more here:http://www.oecd.org/document/34/0,3746,en_2649_34533_44993442_1_1_1_1,00.html)

[2] Defined in this instance as ‘the child poverty rate (the share of all children living in households with an equivalised disposable income of less than 50% of the median for the total population), the poverty rate of households with children (the share of the population in households with children with an equivalised income of less than 50% of the median) and the poverty rate for the total population (the share of all individuals with an equivalised income of less than 50% of the median).

Child poverty, Oct 2011, OECD (available here: http://www.oecd.org/dataoecd/52/43/41929552.pdf)

[3] The poverty trade-off, Oct 2006, The Joseph Rowntree Foundation, p.21 (available here:http://www.jrf.org.uk/sites/files/jrf/1590-poverty-benefits-taxation.pdf)

[4] What Works Best in Reducing Child Poverty: A Benefit or Work Strategy?, 2007, OECD, p.29 (available here:http://www.oecd.org/dataoecd/30/44/38227981.pdf)

[5] Income inequality in this instance is defined as the Gini coefficient. For ease of use, each country’s GI has been multiplied by 100 so as to make the below graph easier to read. Note that a score that is closer to 100 equates to a greater income inequality within a particular nation, whilst the opposite is true for a country nearer 0.

[6] The data used for Figure 3 can be accessed here:  www.oecd.org/else/social/inequality

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