1/1

In-work policies in Europe: killing two birds with one stone?

Olivier Bargain (IZA) and Kristian Orsini (ULB)

2/1

Overview

• Basic idea: exporting the WFTC to continental Europe• Interesting countries: generous social assistance and low

financial gains to work (inactivity traps)… France, Germany, Finland.

• Difficulties: to adapt the reform to three specific institutional settings

• More generally: on the design of in-work policies = analysis of ‘framework conditions’ to evaluate chances of success

• Policy questions: one instrument, two objectives (distribution, social inclusion)

• Oppose two types of policies: family-based vs. individual transfers

3/1

Single (wage = 6 euros/hour)[euros per year]

-10000

-5000

0

5000

10000

15000

20000

25000

30000

'Original' Income

Income Tax 'Original' Income

Social Assistance Employee SICs

Housing Benefits 45 degree line

Disposable Income

Social assistance and suspected traps

4/1

Single (wage = 6 euros/hour)[euros per year]

-10000

-5000

0

5000

10000

15000

20000

25000

30000

1.0E+00

'Original' Income

Income Tax 'Original' Income

Social Assistance Employee SICs

Housing Benefits In Work Benefit

45 degree line Disposable Income

pre-reform Disp. Income

Social assistance and suspected traps

5/1

Social assistance and suspected traps

France Germany Finland

nb of hh on SA 1,729,000 2,700,000 264,000

proportion of hh on SA 7.52% 7.08% 11.21%

Social Assistance (billions EUR)* 5.50 9.40 0.46

Social Assistance (% GDP) 0.38% 0.44% 0.36%

average yearly amount per hh (EUR) 3,181 3,481 1,755

% of hh with EMTR>70% 4.40% 5.90% 5.70%

National statistics for 2001: Federal Minster of Labor and Social Affairs (Germany), Social Welfare Board (Finland), Ministry of Social Affaires (France).

* This includes only direct cash transfers; in particular, it includes cost-of-living assistance but excludes assistance in special situations in Germany; it includes minimum pension in France.

6/1

In-work policies: is there a consensus?• To recreate financial gain to work : Making Work Pay policies : EITC (US), WFTC

(UK), etc. • Officially serve multiple objectives…:

– encourage work– redistribute to low-income families– Reduce child poverty (UK specific)…

• However, difficult to reconcile in one instrument…• …Equity and efficiency objectives often seen as contradictory…• … and much related to the type of instruments:

– Family-based transfers (UK): well targeted / disincentive effect for second-earners (women) and increase EMTRs in some range of earnings

– Individual transfers (Belgium): less targeted / more efficient to enhance work

• The relative consensus (Duncan, 2003) depends strongly on policy objectives• Even then, not so clear:

– Gvt may have efficiency objectives… but creating incentives may also reduce poverty through increased labor income

– Gvt may have distributive objectives… but targeting the working poor does not necessarily mean helping the poorest.

Question 1: How each type of policy reconcile both objectives?

7/1

The UK experience / what if exercise in continental Europe

• WFTC (1999 to 2003) : 7 billion EUR per year, more generous than FC• Evaluation by IFS:

– Positive effect on single women (+34,000), negative on married women with working partners (-20,000) and positive overall effect (+27,000); more in recent studies (+94,000)

– Modest response… WFTC justified on distributive grounds

• France: extensive debate on poverty traps (Bourguignon, 97, Laroque & Salanié, 99,…) but modest measure: refundable individual tax credit (Prime pour l’emploi) / max amount: 443 EUR/y

• Germany: large tax reform 2000-2005 focusing on tax system:– lower tax rate from from 22.9 to 15%,– income tax allowance increased (but non-refundable) / max. gain in the 1st bracket:

1,115 EUR/y– extended exemption of SSC

• Finland: earned income allowance on municipal income tax, not refundable / max. gain: 692 EUR/y

.. Recent orientations toward workfare (Hartz IV, RMA,…)

Question 2: what if these countries have opted for dedicated the same amounts as the UK to MWP policies ?

8/1

Policy simulation

• Few cross-country analyses with behavioral microsimulation: Bourguignon, Spadaro (02): calibration + social welfare evaluation (3 countries) Smith et al. (99): estimation + tax analysis (4 countries) …

• A comprehensive and comparative study: EUROMOD: integrated microsimulation of EU-15 countries Homogenous datasets for 1998 Simple but homogenous labor supply estimation Design of both reform on the same cost basis, after behavioral responses

• Evaluation of family vs individual-based MWP:– ideally: social welfare function (equity/efficiency)– State of the art: set of unsolved questions

• Comparison issues• Social preferences• How to integrate the social value of work in Mirrlees framework (externalities, …)

– Here, clear-cut and pragmatic policy criteria:• Poverty reduction (keeping pre-reform poverty line constant)• Social Inclusion (net effect on employment)

9/1

Reforms

Working Tax Credit

Common features, based on WFTC (2001 figures):

Formula (EUR/w): WTC = 76 − max(0; 55%(z − 128))

Eligibility at 16 hours, premium at 30 discontinuity Full impact on assessment for SA net effect < apparent effect

Low-Wage Subsidy

wage rate increased by a percentage A up to W wage subsidy decreases linearly up to 1.4W W reference wage = first decile cut point of wage distribution no interaction with the tax-benefit system parameter A calibrated iteratively to reach the same cost as WTC : 20% in Fr and

12/13% in FI/GE.

10/1

Budget curves

WTC:

Taper of 55% reduce EMTRs compared to SA / increase EMTRs for upper range

z = jointly assessed income disincentive effect for second-earner (here FR)Single (Finland)

(wage = 6 euros/hour up to full time, linear increase beyond)

0

5000

10000

15000

20000

25000

0 5000 10000 15000 20000 25000

Gross income (EUR/year)

EU

R/y

ear

amount of WTC

original disposableincomedisposable income(with WTC)disposable income(with LWS)

Couple (Germany)

(wages = 6 euros/hour)

0

5000

10000

15000

20000

25000

0 5000 10000 15000 20000 25000

Gross income (EUR/year)

EU

R/y

ear

amount of WTC

net gain due to WTC

original disposableincomedisposable income(with WTC)

first-earner at full time

Note: gross income increases with working hours up to full time (40h/week) then with hourly wage (from 6 to 12 EUR/h)

Note: household gross income increases with the first earner's labor income (first half, up to 12,500 EUR) then with the second earner's labor income (second half, up to 25,000 EUR)

full time

11/1

Labor supply modeling• Data for 1998: BdF, GSOEP, FI Income distribution survey

• Restrictive selection:

– 25-64 y.o., no self employed, no ‘extreme’ households

– No unemployed workers if receive more than SA

– Justification: not the primary target of the reforms, no modeling of demand side (rationing), no simulation of UI (which horizon of responses?)

– Consequences:

• lower bound of the effect; minimize positive effect of the reform

• no more inactive men (single men: one third of SA recipients)… focus on female labor supply

• Married women:

– highest margins for increasing labor supply after reforms

– Lower participation rate in Germany (rationing in childcare facilities), opp. France (schools at 2 y.o.)

– Higher in Finland: individualized tax system, opp. Germany and France (splitting: high EMTRs for 2nd earner)

• Single women:

– Half of welfare recipients

– Lone mothers: smallest gain to work (GE: 25% of them on welfare; FR: many at small part-time)

• Discrete-choice model of labor supply (multinomial logit, Van Soest, 1995) :

– Random utility: Vij = Uij(Cij,Hj) + eij

– Quadratic specification of Uij () as Blundell et al. (2000); fixed costs, no unobs. heterogeneity, senstivity analysis

– Simple discretization: zero, part-time, full-time

– microsimulation (EUROMOD): Cj = g(wi, Hj, ym, yK, Z)

12/1

Framework conditions: behaviors

Wage-elasticities:

– In line with other findings (indicative)– Married: fixed costs larger in GE (childcare)– Singles: high participation in FR

women in couple single women

wage + 1% wage + 1%

Germany

0.62% 0.12%

0.28%0.15%

0.40% 0.16%

country

France

Finland

13/1

Framework conditions: `institutions’

• Interaction with previous system: budget curves + variation in EMTRs

• Participation (condition eligibility to the WTC): hours >15 h/w : 58, 50 and 78% in FR,GE, FI

• Distribution of income (WTC): mode lower in Finland and lower still in France Less recipients in GE, more in FI More hh in the flat segment in FR, more in the phase-out in FI

• Distribution of wage rates (LWS): eligible if in W-1.4 W range …higher concentration in FI and FR more recipients

FINLAND

0

0,2

0,4

0,6

0,8

1

1,2

1,4

1,6

0 0,5 1 1,5 2 2,5 3

% of the sample mean

hourly w age

labor income

FRANCE

0

0,2

0,4

0,6

0,8

1

1,2

1,4

1,6

0 0,5 1 1,5 2 2,5 3

% of the sample mean

hourly w age

labor income

GERMANY

0

0,2

0,4

0,6

0,8

1

1,2

1,4

1,6

0 0,5 1 1,5 2 2,5 3

% of the sample mean

hourly w age

labor income

14/1

Characterization of potential responses

Potential impact on hours: EMTRs

• Proportion of hh with EMTR>70% increases: from 4 to 11% in FR, from 4.2 to 7% in GE/FI

• EMTRs increase in deciles 2 to 5• LWS: slight decrease all over the distribution

Potential impact on participation: financial gain to work (% var. in disp. inc.)

WTC: singles:

average gain increase, esp. in GE and FR proportion of very low gain decreases

married women: proportion of very low gain increases dramatically in FR (from 9.5% to 20% of this

group), more moderately in GE/FI

LWS: only slight increase for single and married women

15/1

Behavioral responsesWTC

Large net disincentive effect on married women in FR: - 168,000 (-3.1%)in GE: - 90,000 (-1.4%)in FI: -3,900 (-0.8%)

Substantial incentive effect on singles in GE : +39,000 (+0.59%)and FI: +3,200 (+0,63%)

Large shift from part- to full-time of singles in FR: +6.2%

net effect = negative (esp. FR) consequence: real cost increases

LWS

Large net incentive effect on married women in FR: + 121,000 (2.25%)in GE: + 62,000 (0.95%)

small in FI : + 1,100 for FI (0.2%)Small incentive effect on singles (FR: + 5,000, GE: +18,000, FI:+ 2000)

positive net effect (esp. FR): real cost decreases

16/1

Cost analysis

• WTC: Net cost falls esp. in GE (interaction with SA)• WTC/LWS: difference in distribution driven by initial conditions

Work ing Tax Credit

apparent cost billion euros/year 5,86 7,66 0,51

net cost billion euros/year 5,74 6,22 0,49

real cost including behav. resp. billion euros/year 7,90 7,17 0,52

% GDP 0,54% 0,33% 0,40%

nb of recipient (hh) % of population 10,1% 9,0% 10,6%

nb after response idem 11,2% 9,5% 10,7%

net average amount per hh (euros/ month) 207 151 165

net average amount after response idem 256 165 172

Low-wage subsidy

net cost billion euros/year 8,30 7,52 0,52

real cost including behav. resp. billion euros/year 7,92 7,25 0,52

nb of recipient hh % of population 22,8% 16,3% 21,9%

nb after response idem 23,2% 16,5% 22,0%

average amount per hh (euros/ month) 132 101 84

net average amount after response idem 124 96 83

Source: authors' computations using EUROMOD.

France Germany Finland

17/1

Distribution

France

01020304050607080

1 2 3 4 5 6 7 8 9 10

am

ou

nt

(EU

R/w

ee

k)

LWS

WTC

Finland

0

10

20

30

40

50

60

1 2 3 4 5 6 7 8 9 10deciles

am

ou

nt

(EU

R/w

ee

k)

LWS

WTC

Germany

0

10

20

30

40

50

60

1 2 3 4 5 6 7 8 9 10

am

ou

nt

(EU

R/w

ee

k)

LWS

WTC

18/1

Poverty reduction

• Significant reduction by WTC but also by LWS in FR

• poverty reduction decreases with lower lines: reforms redistribute relatively more to the `richest' among the poor

• increased labor participation is itself responsible for important moves across the poverty line in GE (double initial figure): large responses on single mothers + the poor are the singles

baseline WTCWTC +

responseLWS

LWS + response

France

poverty rate - line at 50% of the median 7.03% 6.38% 6.35% 6.48% 6.45%

variation in the number of poor hh (line at 40%) -12.2% -12.4% -8.7% -9.3%

variation in the number of poor hh (line at 50%) -9.3% -9.7% -7.9% -8.3%

variation in the number of poor hh (line at 60%) -6.6% -6.6% -7.3% -7.3%

Germany

poverty rate - line at 50% of the median 5.65% 5.51% 5.41% 5.52% 5.50%

variation in the number of poor hh (line at 40%) -4.3% -5.6% -2.8% -3.3%

variation in the number of poor hh (line at 50%) -2.5% -4.4% -2.3% -2.8%

variation in the number of poor hh (line at 60%) -1.2% -3.7% -0.6% -1.2%

Finland

poverty rate - line at 50% of the median 3.75% 3.72% 3.71% 3.67% 3.66%

variation in the number of poor hh (line at 40%) -3.2% -3.6% -4.5% -4.9%

variation in the number of poor hh (line at 50%) -0.7% -0.9% -2.1% -2.4%

variation in the number of poor hh (line at 60%) - - -2.5% -2.5%

Note: poverty line kept fixed at the baseline value

19/1

Cost efficiency

Work ing Tax Credit

Nb of households out of poverty due to the reform 150 121 54 654 583

Nb of households out of poverty due to behav. resp. 5 984 39 748 242

Nb of households back to work -160 937 -51 284 -687

Cost per household out of poverty (EUR) 52 638 131 230 888 575

Low-wage subsidy

Nb of households out of poverty due to the reform 127 528 49 685 1 882

Nb of households out of poverty due to behav. resp. 6 980 9 937 235

Nb of households back to work 125 569 80 477 3 119

Cost per household out of poverty (EUR) 62 143 145 902 276 239

Cost per household back to work (EUR) 63 112 90 077 166 690

Note: poverty line at 50% of the median

France Germany Finland

20/1

Final discussion

Finland: inefficient / demand side to be explored

France: LWS: overall incentive effect WTC: discouraging married women, overall disincentive effect WTC: large reduction in FR; interestingly, LWS performs also well

Germany: LWS: overall incentive effect WTC: larger social inclusion of single women/mothers poverty reduction responses doubled thanks to increased participation

WTC: subsidize married women to stay home .. WTC: double dividend (at least in GE) on group at risk Better design, specific to household type.

Improvements: • disentangle respective role of behaviors and institutions• improve econometric model• broader policy analysis (welfare …)