An Introduction to Microsimulation Tax-Benefit Models

Mininum Income Benefit (£pw)
Tax Credit-type Benefit (£pw)
Basic Income (£pw)

Budget Constraints: Introducing Cash Benefits

I’ll now introduce cash benefits using the same diagram but a different set of inputs.

The low incomes on the left of the diagram might well be below the poverty line; indeed, they might be impossible to live on at all. So it may be necessary to introduce have cash benefits - transfers of money to people depending on their circumstances.

You can broadly classify cash benefits into three types:

In practice benefits are often hybrids of these things, but it’s still a useful classification1.

In this example, we’ll model three different benefits, so we have some new fields on the left-hand-side. The modelling here is very basic; in reality the benefits would have multiple levels depending on age, disability status, number of children, and so on, and detailed rules on who qualifies. But there’s more than enough here to produce some pretty complex results, and to give you a feel for the difficult choices involved in designing a social security system.

Minimum Income Benefits

The first field represents a Minimum Income Benefit2. Job Seeker’s Allowance and Income Support are examples of this kind of benefit3. Minimum income benefits are designed to ensure that people don’t fall below some acceptable standard. If they do, their income is topped up to that standard. Those above the minimum standard don’t receive the benefit. Since benefits of this type are solely targeted on the poor, they can be very effective anti-poverty measures. Against this, since the benefit is the difference between some minimum acceptable level and actual income, if your income goes up by £1 the benefit must fall by £1.

We discussed earlier how means-tested benefits are normally assessed over ‘benefit units’ - roughly traditional nuclear families. A stay-at-home spouse of a high earner would not normally be assessed as poor. For now, we can rather gloss over this point, but family structure comes to be very important when we come presently to our full model with its representative dataset.

In the last section we discussed Marginal Tax Rates (MTRs) as being the wedge between an extra £1 you earn and the amount you get to keep. You can think of a means-tested benefit in just the same way. With a minimum income benefit of this type, in effect you don’t get to keep any of the next £1 you earn, since £1 of extra earnings is matched by £1 of withdrawn benefit.

Q: What’s the implied marginal tax rate here?

In some cases, people on low incomes might also be liable for taxes, and perhaps also eligible for other benefits which are also withdrawn as income rises. So the MTR for low-income people might be a complicated mix of benefit withdrawals and tax increases - it’s possible for these withdrawals to exceed 100% in some cases, so earning an extra £1 leaves you net worse off.4

Marginal Tax rates that mix together deductions from multiple sources are sometimes known as Marginal Effective Tax Rates (METRs), and we’ll use that term from now on.

These very high marginal tax rates on the poor are sometimes referred to as the Poverty Trap - though that’s a phrase with multiple meanings.

Exercise: we invite you to experiment with raising or lowering the minimum income benefit.

Our Average Tax Rate notion can also be applied here. The difference is that the average tax rate for a benefit recipient who is not also a tax payer is negative - net income is above gross income.

In Work Benefits

The next group of inputs model a simple in-work benefit. Examples from the UK are Working Tax Credit5 (WTC) and, to an extent, the Universal Credit (UC) that is gradually replacing it6. In work benefits boost the incomes of people who work at least a certain number of hours but who don’t earn a great deal; they are normally withdrawn gradually as income increases, rather tha £1 for £1.

WTC and UC are normally paid in people’s pay packets, effectively as a deduction from any taxes due, hence the names. In the past, however, they were paid directly to mothers in the same way as child benefit. We’ve just established that we can analyse taxes and benefits in the same way using our METR concepts, so one one level whether WTC and UC are classed as taxes or benefits doesn’t matter to us, but you should also bear in mind here our earlier discussion on the intra-household distribution of income.

We need four parameters for a basic model of such a system:

This is actually a pretty flexible system. For example, you can set parameters here to produce the same results as the minimum income benefit we discussed above.

Activity
  1. Replicate the MIG using the 4 parameters of the in-work benefit. Answer: (maximum payment should be positive 0, minimum hours=0, upper limit = maximum payment, taper=100)

  2. We invite you to spend some time experimenting with the in-work benefit. Things you might want to consider are:

Basic “Citizen’s” Income

The final field represents a basic income7. The the many benefits that make up UK social security all have qualifying conditions of some sort - the examples above have means-tests and hours of work conditions; other benefits are conditional on age, or whether the claimant is disabled in some way, widowed, and much else. All of these conditions need to be checked, and we’ve seen the possible disincentive effects of means tests. A Basic Income sweeps all this away - everyone is eligible regardless of income, health, or anything else.

A Basic Income appears to eliminate the problems we’ve identified with means tested benefits, but it comes at a (literal) cost: since it goes to everybody at all incomes, it’s expensive. Whether a Basic Income reduces poverty or inequality, or improves work incentives, depends on how it’s paid for and the extent to which it replaced or complemented the existing benefit system.

Activity

Try using the in-work benefit framework above emulate a Basic Income Answer: (amount positive 0, qualifying hours=0, upper limit = ∞ and/or taper=0).

Commons Work and Pensions Committee, House of. “Citizen’s Income Inquiry.” UK Parliament, April 2017. https://www.parliament.uk/business/committees/committees-a-z/commons-select/work-and-pensions-committee/inquiries/parliament-2015/citizens-income-16-17/.

Dilnot, Andrew, and Graham Stark. “The Poverty Trap, Tax Cuts and the Reform of Social Security.” Fiscal Studies, February 1986.

DWP. “Jobseeker’s Allowance (JSA).” GOV.UK, 2019. https://www.gov.uk/jobseekers-allowance.

———. “Universal Credit.” GOV.UK, 2019. https://www.gov.uk/universal-credit.

———. “Working Tax Credit.” GOV.UK, 2019. https://www.gov.uk/working-tax-credit.

Network, Basic Income Earth. “Basic Income Earth Network,” 2019. https://basicincome.org/.

Norris Keiller, Agnes, and Andrew Hood. “A Survey of the UK Benefit System,” November 2016. https://doi.org/10.1920/BN.IFS.2016.0190.

Scotland, Basic Income. “Basic Income Scotland.” Basic Income Scotland, 2019. https://basicincome.scot/.


  1. see Norris Keiller and Hood, “A Survey of the UK Benefit System.” for a recent survey of the UK benefits system.↩︎

  2. Minimum Income Guarantee↩︎

  3. DWP, “Jobseeker’s Allowance (JSA).”↩︎

  4. see Dilnot and Stark, “The Poverty Trap, Tax Cuts and the Reform of Social Security.” for a discussion.↩︎

  5. DWP, “Working Tax Credit.”↩︎

  6. DWP, “Universal Credit.”↩︎

  7. see, for example: Network, “Basic Income Earth Network.” and Scotland, “Basic Income Scotland.” for Basic Income advocacy, and Commons Work and Pensions Committee, “Citizen’s Income Inquiry.” for a sceptical view.:↩︎