chapter 3-1 chapter three labour supply and public policy: work incentive effects of alternative...

Chapter 3-1

Chapter Three

Labour Supply and Public Policy:

Work Incentive Effects of Alternative Income Maintenance Schemes

Chapter 3-2

Learning ObjectivesIncome Maintenance Schemes DemograntWelfare ProgramsNegative Income TaxWage SubsidyEarned Income Tax CreditUnemployment InsuranceWorkers Compensation Childcare Subsidies

Chapter 3-3

Income Maintenance SchemesDesigned to supplement low incomesNo single program can address the

multiple reasons for low income Difficult for policy makers to design the

ideal program

Chapter 3-4

Income Maintenance Schemes

Chapter 3-5

Characteristics of a DemograntLump sum transfer Income grantSpecific to a demographic group

Old Age Security (OAS)Universal

Chapter 3-6

demogrant

Work Incentive Effects of a Lump Sum Demogrant

0

U0

T

E0

-income constraint shiftsup by amount of the grant

- slope is the same and there is no substitution effect

- if working time is not altered the equilibriumis E1

Income

Leisure

U1

E1 Y1

Ud

EdYd

Chapter 3-7

Work Incentive Effects of a Lump Sum Demogrant

No substitution effect Work incentives are reducedPure leisure - inducing income effect Increase in income is less than the

demogrant (used to buy leisure)

Chapter 3-8

WelfareAdministered by the provincesFinanced partly by the federal

governmentBenefits depend on

needs of the family, assets other sources of income

Chapter 3-9

Welfare: 100% “Claw-Back”

0

U0

T

E0

- at max leisure the income constraintshifts vertically up by the welfare payment

- potential income constraint is horizontal at the amount of the welfare payment

-strong incentive to move to corner solution

Welfarebenefit

Y0

Uw

Ew

Yw

Chapter 3-10

Welfare:100% “Claw Back”Adverse effect on work incentivesWork is not chosen because of the

100% tax on earned incomeNegative impact on work incentives Not an acceptable policy

Chapter 3-11

U0

E0

Welfare Reduce Benefit

0 T

- lower welfare payments

- no incentive to go on welfaresince the individual is alreadymaximizing at E0

Uw’

Welfarebenefit

Chapter 3-12

Welfare: Reduce BenefitSuccessful in reducing the number of

people on welfareMay deny welfare to those in need Inadequate income support to

unemployable

Chapter 3-13

- wage rate to encourage individuals to voluntarily leave welfare

Figure 3.2 b Welfare:Increase Wage Rate

0

U0

Uw

T

E1

Ew

Welfare benefit

Chapter 3-14

Welfare

Increase Wage Rate through: training job information mobility government wage subsidy institutional pressure (unionization, minimum

wage)

Costly Increase work incentives

Chapter 3-15

- tax by requiring recipients togive up only a portion of welfareif they earn income by working

Welfare:Reduce the Implicit Tax

0

Uw

T

Uw ’

Ew ’

Welfarebenefit

Ew

Chapter 3-16

Negative Income Tax income guarantee Implicit tax rate of less than 100%Recipients receive more from the

guarantee than they will pay out in taxes Child Tax Credit Guaranteed Income Supplement

Chapter 3-17

EoG

Slope=(1-t)w

-income guarantee shifts the income constraint up the amount of the guarantee

0

U0

T

Figure 3.4 Effects of a Negative Income Tax

B

- income support declines as incomefrom work increases

slope = w

Leisure

Income

UN

EN

Chapter 3-18

0

Figure 3.5 Wage Subsidy

T

U0

E0

Us

Es

-as with a wage a subsidy rotates the income constraintupward

-substitution effect and income effect work in opposite directions

Chapter 3-19

Wage SubsidyTheoretically indeterminate Adverse effects of wage subsidy are not

as great as those of the negative income tax

Disadvantage does nothing for the income of those who

are unable to work

Chapter 3-20

0

Figure 3.6 Wage Subsidy vs. Negative Income Tax

T

Uwage subsidy

Es

ENnegative income tax

Leisure

Income

Chapter 3-21

Earned Income Tax Credit (EITC) Two Phases of EITC

• Phase-in: Similar to pure wage subsidy program. Substitution and income effects work in opposite directions.

• Phase-out: Similar to negative income tax. Both substitution and income effects work in the same direction and reduce the incentive to work.

Compared to the welfare program, EITC results in more work incentive

Chapter 3-22

EITC:• Phase-in: It provides a refundable tax

credit equal to 20% of earned income-up to $500 for individuals and $1,000 for families. To target assistance to those with lower incomes.

• Phase-out: The credit is reduced by 15% of net income for individuals earning more than $9,500 and families earning more than $14,500.

Chapter 3-23

Welfare with 100% clawback

Chapter 3-24

Employment Insurance The largest single income security program for

non-elderly individuals in Canada The amount of income replacement rate is 55%

of lost earning, subject to a maximum The duration of benefit ranges from 14 to 45

weeks, depending on the regional rate of unemployment

To qualify individuals must have worked at least approximately 12 to 20 weeks, depending the unemployment rate of the region

Chapter 3-25

Employment Insurance (Worked Example)

Chapter 3-26

Unemployment Insurance-Assisted Work-Sharing

0 7

Y0

U0

E0

2 3 4 Days5 Days

- income falls by 40 percent forevery day of work reduction

-new equilibrium is on higher indifference curve because the individual gets a day of leisurefor only a 40% drop in income Note:Current rate 45%

Es

Ys Us

Chapter 3-27

UI-Assisted Worksharing in Canada an experimental program established in Canada in 1977

under which layoffs were avoided in twenty-four firms by reducing the hours worked of all employees.

Workers take advantage of a temporary modification of unemployment insurance legislation that allowed workers to receive UI benefits for the day or so each week that they no longer worked.

an extra day off per week while experiencing only a 5% reduction in after-tax income.

The experiment ended in 1979, but in January 1982 the government again implemented the program on a temporary basis.

Chapter 3-28

Effect of a Disability Budget constraint or preference curve

could be alteredFactors to be considered:

hours able to work medical expenses reduced ability to earn wages disutility of labour market vs. other

activities

Chapter 3-29

Effects of Disability

Chapter 3-30

Effects of Disability

Chapter 3-31

0

U0

Income

LeisureH0

Y0

Effect of Compensation

Hf

Yd=2/3Y0

- two thirds of the loss of income

- compensation is available for anycombination of partial disabilities

Chapter 3-32

0

U0

Income

LeisureH0

Y0EC

Uc

Compensation: No Incentive to Return to Work

Hf

Utility under compensation isgreater than utility under work

Uf

Not providing compensationwould reduce individual’s utility to Uf

Chapter 3-33

0

U0

Income

LeisureH0

Y0

CUY

Compensation: Restoring Income

Y

M

Ud

• Permanent injury forces individual to locate at Hf

• Medical costs reduce utility to Ud

• Court award for income and medical costs to restore individual income (or utility) to its former level

Hf

Chapter 3-34

0 T

Child Care: Impact on Budget Constraint

Income

Leisure

A

B

E

MCost of Daycare

Y

Y-m

- fixed day-care cost results ina vertical drop in the budget constraint

Chapter 3-35

Daycare: Impact on Participation

0

U0E

MR

Income

LeisureT

E0

Hm

M’

R’

RR’ = Reservation wage if no daycare cost existsMM’ = Reservation wage if daycare cost existsEM = Cost of daycare

Chapter 3-36

Em

0 T

Income

Leisure

M

Day-Care:Impact on Hours Worked

Eo

M’U0

U1

H1 H0Hm

- Eo no child care costs

- day-care costs shift the budget constraint down parallelly since market wages haven’t changed

- indicate the number of hours below which it would not be worth while

to enter the labour market

Chapter 3-37

Day-care SubsidyEncourages labour force participation

and part-time workReduces the hours of work for those

already participating

Chapter 3-38

End of Chapter Three