Child Support Guidelines, Imbedded Alimony and Perverse Incentives

The Maryland legislature has imposed child support guidelines to guide the courts in awarding child support when circumstances dictate that children cannot be raised under a single household. This includes situations where married couples separate and divorce and unmarried parents have children and do not live together.

Maryland expects both parents to be responsible for raising their children in proportion with their gross income. Thus, Maryland is one of the majority of states that use an income share model to determine child support awards. Maryland guidelines reflect the fact that, as parents combined gross incomes increase, so does the amount of funds that parents contribute towards their children. However, unlike some states, Maryland also recognizes that the amount of extra income that parents devote to children decreases as combines gross incomes grows.

However, the Maryland child support system does have shortcomings. For example, the use of combined gross incomes in calculation of child support awards is inappropriate on the grounds that the amount parents devote to raising their children is a function is disposable incomes, not gross income. Thus, the system could be improved by incorporating net income instead of gross income in defining award levels.

Additionally, Maryland’s system, as well as that of all other states, co-mingle different components of child support into one award which leads to perverse incentives.

One component of child support is real economic cost of raising children. Child support should include the cost of rearing children and Maryland has determined that each parent’s obligation should be assigned in proration to each parent’s income. For the purpose of this work, we will define this as child rearing support.

Some would argue that child rearing support is all that is necessary. However, others argue that children deserve to share in the economic status of both parents. Therefore, the child support award should consist of a standard of living component in addition to the child rearing costs.

Under this framework, there are clearly two issues at hand (1) the cost of child rearing and (2) a standard of living increment. It is clear that public policy demands the economic cost of child rearing must be paid. Thus, the cost of child rearing breaks down to a simple calculation which economists should make. If, and how much, the standard of living increment should be is a matter of public debate. Examination of the child support schedules will show that the legislature has decided that there should be a standard of living increment included in the child support award.

The purpose of this study is two-fold:

(1) to disaggregate the child support award into the cost of child rearing and standard of living increment.

(2) to show why the standard of living increment that was intended for the benefit of the children is actually imbedded nontaxable alimony and how that translates into many perverse behaviors.


General Economic Theory And Determining Real Costs

Before gross income proration, the Maryland Child Support Guidelines define basic child support levels which are necessary to support one or more children at various levels of combined gross incomes. Depending upon the custody arrangement and the parents relative gross incomes, that amount (or 1.5 times that amount in cases of joint physical custody) will be prorated to determine each parent’s share of support. If sole custody is awarded, the custodial parent will be presumed to expend that money for the child(ren) and the noncustodial parent will pay the custodial parent his or her share. The money is deemed a reimbursement to the custodial parent and, as a result, can generally be used at the discretion of the custodial parent.

Economic costs are valued at the marginal level (2). For example, what is the cost of having a child in terms of housing? Economically, it is the increase in housing expenditures associated with the child. Therefore, if the birth of a child translates to needing a two bedroom apartment instead of a one bedroom, the marginal housing cost associated with the child would be the increase in rent between the one and two bedroom apartment. All categories of child rearing costs can be examined in the same manner. The sum of all of these marginal costs becomes the total economic cost of child rearing.

In child support development, per capita expenditures have traditionally been used. In other words, a type of average cost measure is used instead of marginal costs (3). The cost of this misapplication is inaccuracy in pricing child support awards. As the Number of Children increase the average cost per child will initially decrease. However, as the Number of Children become high, the average cost per child will increase. This will happen for capacity reasons such as the Number of Children necessitating the purchase of a larger home. Initially, the marginal cost of a child will be below the average costs. However, the marginal costs of additional children will be above average costs when average costs are increasing. Thus marginal costs will only be equal to average costs at two points: (1) when there are no children, which is an irrelevant case and (2) at the single point where average cost per child is at a minimum.

What this generally means as far as child rearing costs are concerned is that average costs will not be equal to marginal costs except by rare coincidence. Put another way, using average costs to estimate child rearing costs will be inaccurate, by design, since one is never an estimate of the other. If the average costs are above the marginal costs, too much child rearing costs are being estimated which will lead to perverse behaviors that are discussed later. If the average costs are below the marginal costs, too little child rearing costs are being estimated. In either event, child are hurt by the outcome.


Data and Methodology

In 1994, Donald Bieniewicz published an article which utilized the U.S. Department of Agriculture’s Family Economics Research Group’s (FERG) estimates of marginal costs for child rearing by category (4). Since FERG used per capita estimates for housing, Bieniewicz imputed the marginal costs of housing from a study conducted by Dr. David Garrod.

The expenditures data was based upon 1992 data and examined three cost categories of single parent families for households having 1, 2 and 3 children. Expenditures were categorized as follows [1] housing, [2] food, [3] transportation, [4] clothing, [5] health care, and [6] child care.

To make this data applicable to comparison with current Maryland Child Support Guidelines, several adjustments had to be made:

(1) Since the data was from 1992, costs had to be translated into 1999 costs. To do this, inflation was assumed to increase at the rate of 2.5 percent per year. This translated to expenditures and cost categories increasing by 19 percent.

(2) In Maryland, basic child support levels generally exclude health insurance and daycare. Hence those categories were excluded from this analysis.

(3) Transportation expenses (e.g., a car and car insurance) is generally a fixed expense and the FERG estimates were on a per capita basis. The presence of additional children generally does not increase this expense and therefore this category is excluded.

(4) Expenditure categories were only available for 1,2 and 3 children. Proper Maryland Child Support Guideline comparison would entail having this data for 4, 5 and 6 (or greater) children. Costs for 4,5 and 6 children were linearly extrapolated with a reliable statistical model (5). The model estimates were used to value the marginal expenditures for 1-6 children. This model should have overstated marginal expenditures since it was modeled as a straight linear function, instead of a decreasing linear function.

(5) Maryland child support guidelines go to $10,000 gross income per month. Because, a significant number of parents earn greater than this amount per month, the guidelines were extrapolated out to $15,000 per month using and ordinary least squares regression which fit the data virtually perfectly (6).

Estimates of Real Costs and Standard of Living Increment

Using the adjusted data, actual child rearing expenses for each cost category were calculated on a monthly basis and compared to Maryland’s child support obligation. The results are reported in Table I through VI.

The results reveal that, at low levels of gross income, child support is insufficient. For example, assume each parent earns $500 gross income per month and the mother has sole custody of one child. The guidelines would suggest that the basic child support is $198 for the child. This would be split between the parents evenly. The mother would be presumed to directly pay $99 per month and the father would be expected to pay $99 to the custodial parent to reimburse her for his share of the child’s direct expenditures. However, the true cost of raising the child is $291 (Table I). Thus the 'Standard of Living Portion' of the award is - 93 of which both parents should absorb ½. Because the mother expends the resources on the child she absorbs her half. However, she also absorbs the father’s half. Essentially, she is paying the father $46.50 in non taxable alimony per month.

The reverse occurs for higher income parents. Assume each parent in the above situation was earning $5000 per month instead of $500 per month. Under the same custody arrangement, Maryland would suggest the basic child support obligation was $1042 per month. However, the economic cost of raising that one child is $505 (Table I). Under this situation, the mother’s expenditures would be presumed and the father would pay $522 per month. Of the $522, his share of the child rearing costs would be about $202. In essence, he is paying $320 for a standard of living increment for the child.


Why Imbedded Alimony Causes Perverse Behaviors

On the face of it, the noncustodial parent is paying $320 to the mother as a benefit of his economic status to the child. In theory, these funds are to be expended to the child’s benefit. However, it is questionable how much of these funds get to the child and how much directly benefit the custodial parent. The loss of benefit to the child is certainly one problem. However, perhaps the greater problem results from the benefit to the custodial parent because the custodial parent now has an incentive to act in a manner consistent with his or own best interest at the expense of the child.

Since use of the $320 in funds is at the mother’s discretion, she will allocate the funds in a manner to achieve maximum utility (satisfaction). Standard economic theory suggests that she will expend some portion on the children and some portion on herself. Given a budget constraint ('Standard of Living Portion') and choice between two goods (goods for children versus other goods), a rational consumer will generally choose some of each good over all of one (i.e. a consumer’s indifference curve is generally convex) (7).

The ability of the custodial parent to do this is why 1/2 the 'Standard of Living Portion' that the noncustodial parent pays is, in reality, nontaxable imbedded alimony, not child support. Hence the legislatures presumed purpose of increasing the standard of living of the child does not materialize in the manner that was intended.

There are, however, other consequences to this problem. The existence of imbedded alimony generates at least two perverse incentives that are harmful to children:

(1) There is an economic incentive of the parents to now have sole custody and exclude the other parent from the child’s upbringing. Parents are now more likely to fight for sole custody at the expense of the best interests of the children. For example, it is standard practice for an attorney to warn a sole custody parent to limit contact between the child and the other parent or risk a reduction in child support award. If the child support was correctly priced, a parent would be, at worst, economicly indifferent as to whether the other parent saw the child. In fact, to the extent that the other parent taking care of the child decreases the custodial parents burden, the behavior of increased participation would be encouraged. This incentive is particularly disturbing in light of a significant body of research that show the best adjusted children of divorce are those in which both parents are involved in rearing the children.

(2) Nontaxable imbedded alimony increases the incentives to have out-of-wedlock births. Under the current child support system, having a child is an economic benefit regardless of marital status. Further, there is an incentive to have children from multiple fathers since child support schedules award the greatest percentage of child support award to gross income for one child.


Solutions to Consider:

It is generally much easier to criticize than to provide solutions. Here I will suggest some solutions designed to make the child support system work in a manner that is economicly sound and incentive neutral. The general solution I propose would be to disaggregate child support into two components, much like what has been done in this analysis. In other words, explicitly define one type of child support as child rearing support and the other type as standard of living support. Once this is achieved, these components can readily be treated differently to achieve better outcomes.

(1) Child rearing costs are the true costs of raising the child. Generally speaking, a parent should be compelled to pay this amount regardless of circumstances. This component should be expended at the sole discretion of the custodial parent since it is indeed a reimbursement for expenses incurred.

(2) 'Standard of Living Portion' should be handled differently. These funds should be mandated for the exclusive use of the children and be used at the discretion of the noncustodial parent unless a court decides that this is not in the best interest of the child. One example of this could be the noncustodial parent making direct contributions into a savings account for the children’s college education. Another example might be this component being directed into a child’s account who’s use requires the approval of the noncustodial parent. Why is the noncustodial parents discretion over this fund superior to the custodial parents discretion? Since the funds are mandated for use of the children, the noncustodial parents will maximize the children’s utility which is disassociated from his own utility (except to the degree that the noncustodial parent’s utility will be greater when the children’s utility is maximized). At a more fundamental level, this system would more closely replicate the way a child would receive the economic benefit from a parent in an intact household. Further, it would keep the noncustodial parent involved in the child’s life. In this manner, the child is ensured to receive all of the benefit of the 'Standard of Living Portion', as presumably intended by the legislature.

Finally, this would help one additional problem. Child support guidelines, across the U.S. do not take into account children and families subsequent to divorce. All children have a right for equal support from their parents, however, the court has a difficult time equating children from different marriages (or unmarried arrangements) since each parent-child set in handled separately. The clearly defined distinction between child rearing costs and standard of living increment radically simplifies a court’s analysis of the problem. For example, the court may decide that the cost of child rearing is inflexible and the 'Standard of Living Portion' should be split between the all children.


Concluding Remarks

The purpose of this analysis is to simplify the child support problem, reduce perverse incentives which leads competing parents to act in a manner inconsistent with the best interests of the children. As this paper suggests, separating awards into components and handling them different can go a long way toward improving the system.

Estimating real costs of child rearing is a relatively simple application of an economist’s trade. This can be done in an objective manner, devoid of political jockeying. The standard of living increment is a matter of pubic debate. However, whether the legislature decides that the appropriate amount of funds should be zero or half of the noncustodial parent’s pay is irrelevant as long as this portion of funds is clearly defined, separable from the cost of child rearing and is expended at the discretion of the noncustodial parent.