Child-Related Transfers, Means Testing and Welfare

Should government transfers to families with children be means-tested? We revisit this question from the unique Australian policy context, where all child-related transfers are strictly means-tested. Using household survey data, we first demonstrate that means testing effectively directs child benefits to low-income Australian families with children, comprising up to 40% of their gross total income during the childbearing period. Notably, this coincides with the distinct M-shaped labor supply pattern of Australian mothers over the life cycle. Combining these empirical facts with a dynamic general equilibrium overlapping generations model of single and married households with children, we quantify the aggregate and distributional impacts of child-related transfers. Our simulation results demonstrate the significant adverse effects of means testing on work incentives and human capital development among mothers. A structural reform that replaces the status quo means-tested system with a universal system improves female labor supply, output, and overall welfare while also garnering majority support. However, the universal system increases tax burden by 4 percentage points and negatively impacts single mothers-the intended beneficiaries-by reducing their net lifetime income and welfare. In our model, inclusion of means testing is essential for controlling fiscal costs and mitigating the adverse effects of higher taxes. Preserving the existing means-tested system and opting for incremental reforms could potentially result in modest improvements in output and welfare while ensuring a more equitable distribution of welfare gains. Hence, our findings highlight the complex trade-offs between efficiency and equity in designing child benefit programs.