Topic 2.3a - Social Programs. Professor H.J. Schuetze Economics 370. Alternative Income Maintenance Schemes

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1 opic 2.3a - Social Programs Professor H.J. Schuetze Economics 370 Alternative Income Maintenance Schemes Governments in Canada spend over 10 percent of GDP on income maintenance schemes he effectiveness of programs such as Social Assistance is a hotly debated topic. Critics of such programs argue that these programs create too much of an incentive not tto work and dfosters dependency. d Let s examine how such programs alter the opportunity set and affect labour supply. Professor Schuetze - Econ

2 Alternative Income Maintenance Schemes he income-leisure choice model is a convenient starting point to analyze work incentive effects We can think of all sorts of labour market programs as just being changes to the budget constraint. We should be aware that such analyses are restricted t to partial equilibrium i effects We will do a few examples here but there are many possibilities. Professor Schuetze - Econ Example: Simple Welfare Program Welfare or Social Assistance in Canada is administered by the provinces but the benefits are paid, in part, by the Federal Government he amount of benefits depends d upon family type, needs of the family, assets and other income Most programs offer a cash grant to eligible individuals -- let s say $1000 per month if not working. Welfare recipients can work but the cash grant is reduced in proportion to the income earned in the labour market. Let s suppose the government takes away 50 cents for every dollar earned (although for many this is 1 dollar). Individual works 2 hours for $10 an hour labour income is $20 but grant is reduced by $10 otal Income = $10. Like a tax on the wage of 50%. Professor Schuetze - Econ

3 Example: Simple Welfare Program Y($) Slope = -10 A C $1000 F E D Slope = -5 Welfare Program: Increases non-labour income Reduces the net wage h* h W B h (leisure) With preferences as drawn the individual id opts for the welfare program and choose bundle E over F. Looks like it does have a disincentive effect. We can prove this using income and subs effects. Professor Schuetze - Econ Income and Substitution Effects Y($) A Income effect? C $1000 F G E h* h W B h (leisure) F to G is the income effect (cash grant) reduces hours worked G to E is the substitution effect (tax on earnings) also reduces hours. he substitution effect is still smaller than if the implicit tax were 100% as is often the case in Canada Professor Schuetze - Econ

4 Reducing the Disincentive Effects Are there ways in which policy makers can reduce the disincentive effects of social assistance? 1. Reduce the cash grant (income effect) - Problems? 2. Reduce the implicit tax rate (substitution effect) - Still leaves individuals on social assistance 3. Change preferences for social assistance e.g. create a stigma - Stigmatize those who have little or no choice 4. Raise market wages through training etc. (workfare) - Appears to be the most promising Professor Schuetze - Econ Empirical Evidence Very difficult to estimate the impact of changes in welfare parameters Some have used cross-jurisdictional (cross- province) differences in welfare programs Generally find the more generous the system the lower is labour force participation However, this could be because jurisdictions with greater need respond with greater generosity Self-Sufficiency Project (SSP) Offers a wage subsidy to welfare recipients who maintain i full-time jobs Workers were randomly assigned to treatment and control groups to avoid self-selection Results suggest that the wage subsidy had a positive effect on work Professor Schuetze - Econ

5 Empirical Evidence Negative Income-ax Experiment: Negative Income-ax is essentially the same as welfare except eligibility (based only on income) Experiments were as follows: Offer different cash grants and tax rates randomly to eligible households across the US and Canada. Record the impact on labour force outcomes. Results: Consistent with our theoretical model Presence of negative income tax reduces hours For most groups both the cash grant and the implicit tax rate matter Changes to the cash grant had a bigger effect Professor Schuetze - Econ Employment Insurance Provides insurance against spells of unemployment Why might we want this? Provide income during unemployment spell Allow for optimal search Who qualifies? Must have worked hours (12-20 weeks at 35 hours) depending on the local unemployment rate Benefits? 55% of earnings subject to a maximum Duration of benefits depends upon the local unemployment rate Professor Schuetze - Econ

6 Example, Employment Insurance Scheme $ A Suppose the replacement rate is 60% and the duration of benefits is 20 weeks Also suppose you must have a minimum of 14 weeks of employment to qualify Net wage=w-0.6w=0.4w B Net wage=w D C } (0.6)20w - One year time horizon - w = weekly wage - If work less than 14 weeks you do not qualify - Still on initial budget constraint - Work 14 weeks and you become eligible for 20 weeks of benefits - Increases potential income by (0.6)20w F =52 l - You can earn weekly earnings and still be eligible to collect EI for up to 32 weeks (52-20) - You can t work and collect EI at the same time so any week worked beyond 32 has an opportunity cost equal to (0.6)w Professor Schuetze - Econ Notes on Employment Insurance Scheme he budget constraint with the employment insurance scheme (shaded in red) represents the potential budget constraint Most people won t leave their job to collect Employment Insurance as they might not be able to return to the job he red shaded portion may apply to seasonal workers, those working for family etc. For these workers what are the likely incentive effects of the Employment Insurance Scheme? he likely effect depends on the optimal location on the budget constraint in the absence of EI Professor Schuetze - Econ

7 Effects of Employment Insurance Scheme 1) Not in the labour Force ($) b a l (leisure) Such individuals value leisure a great deal he EI scheme could potentially induce such workers to work just enough weeks to qualify for EI May, therefore, create an incentive for these workers to work (albeit just briefly) Professor Schuetze - Econ Effects of Employment Insurance Scheme 2) Middle Section of Income Constraint ($) b a l (leisure) his is a pure income effect. Such workers will certainly reduce hours worked. Professor Schuetze - Econ

8 Effects of Employment Insurance Scheme 3) Upper Portion of Income Constraint ($) a b l (leisure) Likely result will be a reduction in weeks worked. he income and substitution effects both work in the same direction Professor Schuetze - Econ Child Care Costs and Subsidies We can think of the cost of child care as a fixed cost associated with working If you decide to work you pay the full cost of child care (cost doesn t depend on the hours worked) ($) A B If you work at all the budget constraint shifts down by the cost of child care (E-M) E M l (leisure) Professor Schuetze - Econ

9 Effect of Child Care Costs on Participation ($) R M o look at the effect on participation let s start by examining the reservation wage with and without day care costs Without t Day Care Costs: - Reservation wage equals the slope of the budget constraint at (R-R ) With Day Care Costs: - Want the wage at which the individual is indifferent between working and not E - i.e. puts the individual on M R - his is the slope of M-M l Not surprisingly, the reservation wage with day care costs is higher his implies a lower participation rate with such costs Professor Schuetze - Econ Effect of Child Care Costs on Hours ($) A Suppose the individual would choose to work even when faced with day care costs B l 1 l 0 E M leisure In the absence of day care costs the individual might work (-l 0 ) hours Day care costs represent a pure income effect herefore, the worker would decrease the amount of leisure (work more) with such costs he individual must work longer to make up the costs of day care For those working, child care costs increase hours worked Professor Schuetze - Econ

10 Effect of Child Care Costs on Hours We can also show that day care costs reduce the likelihood that individuals will work part-time here is a discontinuity in the labour supply curve ($) M l M E M l At wages lower than the reservation wage (M-M ) the individual does not participate When the wage reaches the reservation wage the individual would work (-l M ) hours he individual would never work fewer than (-l M ) hours It is simply not feasible to spread the fixed costs of day care over so few hours Professor Schuetze - Econ Day Care Subsidy Suppose that a child care subsidy is offered such that day care is paid for out of public income What would the likely impact be? 1. Increased participation among those who found the costs too inhibiting 2. Part-time work would likely become more attractive 3. A reduction in hours worked by those in the labour market would likely occur his would not induce participants to leave the labour market he subsidy would simply lower the reservation wage even further Professor Schuetze - Econ