Research Paper IFS Working Paper Series 13/01
How taxes and welfare distort work incentives: static lifecycle and dynamic perspectives
Personal taxes and benefits affect the incentive to work over the lifecycle by altering income-age profiles, insuring against adverse shocks, and changing the returns to human capital. Previous work investigating the impact of taxes and benefits on work incentives has tended to ignore these dynamic considerations. In this paper, we use a dynamic model to show how a lifecycle perspective alters our impression of the effect of the tax and benefit system on female work incentives. We describe how work incentives change over the life and show how they depend on lifecycle circumstances. We also devise a forward-looking measure of work incentives that incorporates all the dynamic considerations likely to affect work decisions at any given age. We find that individuals experience considerable variability in work incentives across life that outweighs the variability across individuals. Changes pattern of family types across life is key to explaining these patterns: work incentives vary dramatically depending on family composition, and most women experience a number of different family types during the course of their lives. We also find that differences in family type are an important explanation for why static and forwardlooking PTRs diverge, though this is more to do with differences in how women in families with different compositions behave.