Teddy Bears Picnic: The Recession Diaries - October 16th

‘Minister Lenihan) warned the cuts proposed by An Bord Snip Nua would be a picnic compared to what future governments would have to implement.’

As we are all frog-marched down to the Finance Minister’s picnic, let’s see what effect cutting Child Benefit will have. For all the indications are that this payment is in the firing line. Many have argued that it’s a no-brainer – sure, doesn’t Child Benefit get paid to rich folk? Doesn’t that mean it’s regressive? We could cut the payment without harming (too much) low and average income groups – and save the state a lot of money.

The ESRI has done the debate a considerable service by analysing the effects on different income groups from (a) a cut of Child Benefit of €26 per month, and (b) including Child Benefit in taxable income. Briefly, this is there conclusions:

• Cuts in Child Benefit rates will impact much more severely on low/middle income groups, resulting in a rise of 17 percent in child poverty. This would reduce expenditure by between €400 and €450 million.
• Taxing Child Benefit will impact less on low income groups (though its effect on middle income groups will be the same) with only a small rise in child poverty of 3 percent. This would reduce expenditure by €370 million.

If one had to choose between the two – you’d pick the tax route: less regressive, less impact on child poverty, and approximately similar levels of reduced government expenditure. Even so, there are issues.

While cutting Child Benefit would be woefully regressive, the effect on middle incomes – the 2nd and 3rd quintiles - will still be slightly more regressive than those on higher incomes. It’s a matter of the least worst solution.

Bear in mind, the ESRI doesn’t model these proposals to assess the actual net savings that would be gained nor the impact on the economy. The net savings would be less, of course – arising out of reduced spending taxes, the knock-on effects of reduced consumption and a slight downward revision of the GNP. Therefore, the savings would not equal the reduction in expenditure.

However, there are two fruthe important considerations that should be factored in before passing judgement on the issue of taxing Child Beneft. This not a criticism of the ESRI researchers – their findings advance our understanding. But let’s advance that even more – by using the CSO’s Household Budget Survey. This cannot be neatly integrated into the ESRI’s model – so it should only be treated as indicative. And the latest data comes from 2005. But it indicates that the impact on low and middle incomes will be much greater than merely measuring the effect on disposable income.

Households and Debt

Irish personal debt is one of the highest in the world and, as the recent Goodbody report suggested, it is potentially an even greater danger to the economy than public debt. The Household Budget Survey doesn’t measure debt as such, but it does measure income and expenditure by income groups.

Those in the lowest income groups are more likely to find their income not enough to meet their weekly outgoings. This deficit does not directly equate to debt, but it is a strong indicator and confirms numerous reports about debt levels among low and middle income groups. So while debt is spread throughout all income groups, it is likely to be more severe – as a proportion of income – in the lower quintile groups. In addition, low and middle income families are less likely to have the ability to adjust their expenditure budgets to close the gap – hence, the debt trap.

As stated, these numbers date from 2005. But since then, private debt has escalated – though the majority of this debt is tied up in housing. In the middle of this recession – with people losing their jobs or experience wage cuts / reduced working hours, along with levies and social welfare cuts; well, we shouldn’t be surprised to find debt problems mounting among lower/middle income groups.

Therefore, reductions in disposable income arising from Child Benefit cuts (or indeed any cuts to income) will impact even harder on those households experiencing and trying to get out from under debt.

Disposable Income after Necessary Expenditure

The ESRI assessed the impact on disposable income – which is valid. However, within disposable income there are necessary expenditures. Though there is a considerable debate over what those ‘necessities’ are, we can certainly agree that food, housing and utilities (fuel, light, telephone and TV licenses) are necessities. Let’s deduct these from disposable income and see what happens.

Not surprisingly, necessary expenditure makes up a higher proportion of disposable income at the lower end. And this doesn't include clothing and footwear, household and personal items, transport, or the full range of services.

The corollary of this is that ‘actually existing’ disposable income is considerably reduced for low income groups and less so for high income groups. The following tries to asses the impact, therefore, of taxing Child Benefit on ‘actually existing’ disposable income. I emphasise, this is just a rough calculation. It is based on 2005 numbers. I don’t have access to the data or the SWITCH tax benefit model that the ESRI has. But it is a signpost, pointing to the need for more research on the impact of taxes and spending cuts in general. What does the rough approximation tell us?   This is not hard and fast. But what does it show is:

• The effect on the lowest and highest incomes is the same in terms of percentages.
• The effect on incomes in the lower half (2nd quintile) experience a a more severe hit than those on the highest
• Those in the middle suffer the worst decline

Again, none of this should be too surprising – though with updated numbers we might find different percentages. But the balance would be roughly the same. And this doesn’t take into account the debt problem that low and middle income earners face.

At the end of day, cutting Child Benefit – either through reducing the payment or taxing it – will be regressive and will hit low and middle income groups hardest (though reducing payments would be the worst option). This, in turn, will have a significantly deflationary effect on the economy, for these are income groups who have a higher propensity to spend. This is especially the case for households with children. This will cut economic growth, cut consumer spending and, therefore, substantially reduce the savings coming out of these cuts and have only the most fractional, if any, effect on the deficit burden.

This is not a good day’s work. But who said the Minister’s Teddy Bear picnic would be fun.

Comments

[Proposition Joe]

Have you considered the complications/inequity of the taxation approach for separated or divorced parents, or indeed undeclared co-habitors?

A more equitable outcome could be produced by cutting the rate, but also handing back some of the savings to the poorest families via increased rates of Family Income Support.

[Tomaltach]

Michael,
A very useful analysis. What I would say is that each spending and tax adjustment needs to be modelled and its effects on the income distribution examined for fairness - as you have done here. But then the combined effect of a proposed bundle of measures (tax + spending) needs to be examined. If the Child Benefit were taxes as you show the middle income group is worse affected. But if the tax system is made a bit more progressive, for example by closing certain expenditures, removing PRSI ceiling and say, if there were to be a third band, then the overall effect could be 'evened out'

Still Joe makes a good point about the complications for separated parents.