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

1. In-work policies in Europe: killing two birds with one stone? Olivier Bargain (IZA) and Kristian Orsini (ULB)

2. 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 Overview

3. Social assistance and suspected traps

4. Social assistance and suspected traps

5. Social assistance and suspected traps

6. 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? In-work policies: is there a consensus?

7. 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 ? The UK experience / what if exercise in continental Europe

8. 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) Policy simulation

9. 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. 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)

11. 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. Framework conditions: behaviors Wage-elasticities: • In line with other findings (indicative) • Married: fixed costs larger in GE (childcare) • Singles: high participation in FR

13. 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

14. 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 Characterization of potential responses • 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. WTC 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 Behavioral responses

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

17. Distribution

18. 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

19. Cost efficiency

20. 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 …) Final discussion