Abstract
II. Welfare and Labor Market Reform in the United Kingdom Evidence from the International Experience
Contents
II. Welfare and Labor Market Reform in the United Kingdom Evidence from the International Experience
A. Introduction
B. Labor Markets in the United Kingdom
C. Tax and Welfare Reforms in the United Kingdom
Working Families Tax Credit
National Minimum Wage, and Changes to Income Tax and National Insurance
New Deal for young people and New Deals for other groups
Future Plans
D. International Evidence
Increases in the Minimum Wage
Changes in the Institutional Structure of Welfare
Canada
Other countries
Denmark
New Zealand
Netherlands
Sweden
E. Conclusions and Implications
References
II. Welfare and Labor Market Reform in the United Kingdom: Evidence from the International Experience1
A. Introduction
1. The United Kingdom has undertaken a series of welfare and labor market reforms aimed at increasing labor market participation among current welfare recipients and reducing income inequality and the prevalence of poverty, especially among children. This paper examines these issues from an international perspective, using the experience of other countries to inform the analysis of the measures taken in the United Kingdom. This is possible because the U.K. reforms in large part draw on practices that have been found to lead to increased employment among welfare recipients in other countries, especially the United States, but in all cases adapted to U.K. circumstances and priorities. A principal focus of this paper is on the tradeoff between program costs, efficiency in terms of increased labor supply and thus output, and concerns about equity such as reduced poverty and improved income distribution.
2. The measures taken in the United Kingdom appear to have somewhat of an emphasis on reducing poverty and inequality over raising overall employment or labor force participation. This is because a central element of the welfare reform provides an incentive for one member of a household to work but discourages the second. But this is a reasonable choice for the United Kingdom, which faces the particular problem that unemployment is concentrated in households where no adult is employed rather than more evenly dispersed throughout households, a phenomenon that likewise results in a concentration of poverty, including child poverty, within these workless households. Having one adult in the workforce can break the intergenerational cycle of poverty and welfare dependence that results from children growing up in households in which there has never been a working adult. The net increase in labor supply and thus the macroeconomic benefits in terms of increased output and productivity might be fairly small in the near term, but this does not detract from the promise welfare reform holds for reducing inequality and joblessness among affected households, and breaking the United Kingdom’s intergenerational pattern of poverty and welfare dependence. And macroeconomic gains are still possible over a longer horizon, as current welfare recipients gain work experience that leads to increased productivity, earnings, and output.
3. An important aspect of the reforms in the United Kingdom is that they are largely based on enhanced in-work benefits—support that enriches the reward to employment and is thus available only to those who leave welfare. This includes both financial incentives and training and other personal assistance for welfare recipients who seek to move into employment. This contrasts with measures in countries such as Denmark and New Zealand that have sought to encourage participation by reducing benefits to the unemployed. Although initially expensive, use of the in-work benefit may prove socially more acceptable and thus more effective over the long term. It must be recognized, however, that in-work benefits leave behind those who do not take advantage of the new opportunities, and that there will remain a core of those at the very bottom who are not able to take advantage of the additional assistance; for this group, welfare reform in the United Kingdom leaves the social safety net largely unchanged.
4. The paper next examines the recent performance of the U.K. labor market in comparison with other advanced economies. Reforms in the United Kingdom are discussed in Section III, after which Section IV explores the implications of other countries’ experiences. Section V concludes.
B. Labor Markets in the United Kingdom
5. Welfare reform in the United Kingdom is being undertaken in the context of a booming economy and strong labor market—possibly the only circumstance when programs that feature higher benefits could be fiscally possible as a means to entice the economically disenfranchised into the labor market. The unemployment rate has fallen to historical low levels (Figure 1), while employment growth since the 1992 recession has been faster than in the other large industrial economies in Europe, behind only Ireland and the Netherlands (Figure 2). Note, however, that the youth unemployment rate remains higher in all countries than the overall unemployment rate, with only Germany coming close to parity. And reduced unemployment has not come through increased retirement as a means to remove older workers from the labor force, as the labor force participation rate has remained stable in the United Kingdom in recent years at a rate higher than in the other large economies in Europe, behind only Sweden and Denmark (Figure 3).
Unemployment Rate, October 1999
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Unemployment Rate, October 1999
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Unemployment Rate, October 1999
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Employment Growth, 1993-98 average
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Source: OECD and EurostatEmployment Growth, 1993-98 average
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Source: OECD and EurostatEmployment Growth, 1993-98 average
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Source: OECD and Eurostat
Labor Force Participation Rate, 1997
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Source: OECDLabor Force Participation Rate, 1997
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Source: OECDLabor Force Participation Rate, 1997
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Source: OECD6. Underlying the aggregate gains in employment has been a secular shift in the composition of the U.K. economy, as the process of deindustrialization and skill-biased technological change has led to an increase in the demand for skills at the expense of less-skilled workers.2 This process has meant worsened job market prospects for less-educated workers, including the large group of older workers displaced by the long decline of the U.K. mining and manufacturing sectors. For example, HM Treasury (1998) notes that in 1997 only 5 percent of prime age men with a degree were not in work, compared to one-third of those with no educational qualification—a remarkable change from the figures of 3 percent and 10 percent, respectively, in 1979. A further stylized fact of the U.K. labor market is that while the unemployment rate has declined, average duration on unemployment has increased—those who do not move out of unemployment quickly tend to remain jobless.3
7. A feature of the United Kingdom welfare state crucial for understanding the design of recent reforms is that inactivity is concentrated in jobless households rather than more evenly dispersed throughout the population as would be the case were one adult in a couple working and the other unemployed. In 1998, 17 percent of U.K. households had no adult working, up from only 9 percent in 1979, while 18 percent of the population lived in a workless household in 1998. Some of these workless households are of course not of working age, but as recently as 1991, when 16 percent of households were workless, only 7 percent were pensioners. Of particular concern is that 19 percent of children in the United Kingdom in 1998 were in workless households, compared with less than 10 percent in France, less than 5 percent in Germany, and 10 to 12 percent in Belgium and Spain. An important aspect of the concentration of worklessness in jobless households is that single parents are less likely to work in the U.K. than in other advanced economies: in 1997, only about 40 percent of lone parents were employed, compared to 82 percent in France and 60 percent in the United States.4 And the 40 percent employment rate for single parents in the United Kingdom is 8 percentage points lower than in 1979, even as overall female labor force participation in the United Kingdom rose from 57 percent to 66 percent over this period. The phenomenon of workless households leads to an intergenerational cycle of poverty and welfare dependence, in which children grow up in an environment with no employed adult as a role model, including both parents and grandparents. This has led to an emphasis on ensuring that one adult in each household is employed even at the risk of providing disincentives for participation by the second adult in couples. This is discussed in the next section, which examines the specific programs enacted in the United Kingdom.
C. Tax and Welfare Reforms in the United Kingdom
8. Extensive changes to the structure of the tax system, labor markets, and the social welfare system began in the United Kingdom in the late 1970’s, following two decades in which the welfare state had grown in the United Kingdom as in other advanced economies. The tax system underwent fundamental reform in 1979, with the establishment of individual rather than household taxation, and the lowering of tax brackets as revenue moved to indirect taxation. The current system features an individual tax allowance large enough to exclude part-time low wage earners (largely married women), with earnings above the exemption facing progressively higher tax rates of 10, 22, and 40 percent—the 10 percent band was instituted in April 1999 as an incentive for labor force entry for low earners, while the middle rate falls from 23 percent as of April 2000. National Income Contributions are paid by employees at a rate of 10 percent on all earnings above a lower earnings limit.
9. Despite the individual basis of taxation, the welfare system features means tests on earnings and assets for the entire household, so that earnings by the second partner can reduce benefits that accrue from the first adult being unemployed. Income Support (IS) is provided to individuals who are not expected to work, such as lone parents, carers, and those over 50 years old; this provides a small income disregard (£5-15/week)—the amount of earnings allowed before benefits are reduced—after which benefits are “tapered” at a rate of 100 percent, meaning that the amount of the benefit is reduced by one-to-one with earnings for an effective 100 percent tax rate. The Job Seekers’ Allowance (JSA) program of unemployment insurance is available for an initial 6 month period only to those who have previously paid contributions, and then to all unemployed after six months. Working 16 hours per week eliminates eligibility for JSA and IS, and triggers reductions in associated benefits such as subsidized meals for schoolchildren and prescription drug benefits. Other benefits, such as rental subsidies under the Housing Benefit and rebates on property and local tax under the Council Tax Benefit are reduced at rates of 65 percent and 20 percent once net income after taxes and the disregard exceeds the level provided by Income Support.
10. The social welfare system is less extensive in the United Kingdom than in most other industrialized economies in Europe, with the share of transfers out of GDP lower than all but Ireland, Germany, and Spain (though, again, above the United States, Canada, and New Zealand), and the share of government workers out of employment the lowest in Europe except the Netherlands (Figure 4). Lower replacement rates—the value of welfare benefits relative to earnings from full-time employment at the minimum wage—similarly indicate the less generous nature of welfare in the United Kingdom than in the rest of Europe.5 The major new programs of the past three years constitute an expansion of the system, but in ways that are targeted to provide incentives for welfare recipients to move into employment rather than as general assistance for the jobless. The new programs include financial incentives for moving into employment in the Working Families Tax Credit, the National Minimum Wage, and other reforms to tax and benefit programs, and the active labor market program of the New Deal for Young People and the other New Deals. These are examined in turn.
Size of the Welfare State. Shares of Transfers and Government Employment, 1997
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Source: OECDSize of the Welfare State. Shares of Transfers and Government Employment, 1997
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Source: OECDSize of the Welfare State. Shares of Transfers and Government Employment, 1997
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Source: OECDWorking families tax credit
11. The Working Families Tax Credit (WFTC), introduced in October 1999, is at the center of the reforms to the tax and benefit system. It provides a refundable tax credit for families with children where at least one adult works 16 hours per week or more, an additional benefit for full-time work of 30 hours, and a generous child care subsidy for single parents and couples where both partners work. The use of the in-work benefit is meant to provide an incentive for individuals to take low wage jobs that would otherwise provide only a small boost in income over welfare. The credit is after-tax income, but reduced at a rate of 55 percent for weekly after-tax earnings above a specified threshold.6 The WFTC effectively guarantees a weekly income of just above £200 for a family with one child and one adult working full-time, enriching the minimum hourly wage of £3.60 by nearly 40 percent. Nearly all of the benefits are obtained even for part-time work, suggesting a belief that it is worthwhile for at least one person in each household to maintain some labor market attachment rather than for a family to depend completely on welfare. The WFTC is expected to be taken up by around 1.4 million households, 40 percent more than the less generous Family Credit (FC) that it replaced (the Family Credit involved smaller benefits and a 70 percent withdrawal rate for all components).
12. A side-effect of the increased benefit and lower taper compared to the FC is that the WFTC provides a disincentive for work over a larger range of hours than was the case under the FC. This can be seen in Figure 5, which shows the 2000-2001 tax year WFTC benefit received by a couple with one pre-teenage child and contrasts this with the amount previously received under the Family Credit.7 The figure is drawn to first show the benefit with only one earner at £4 per hour, and then for the household as the second adult earns the minimum wage of £3.60 with the first earner at 40 hours. For the first adult, the WFTC provides a larger incentive for participation at 16 hours than was the case with the less generous FC, and because of the 15 percentage point reduction in the taper rate, a smaller disincentive for additional hours beyond the 16 and 30. The biggest gains accrue to a household with the second earner working part-time that was previously just beyond receiving any FC benefit, since this household is eligible for the WFTC. However, the 55 percent effective tax rate from the taper affects the second earner all the way until 30 hours, whereas the FC benefit goes to zero—and thus the effective tax rate of 70 percent disappears—at 8 hours. This is an unavoidable dilemma, since a reduction in the taper rate increases the reward to working, but extends the disincentive of benefit withdrawal over a larger range of hours. The net effect on hours and participation thus depends on the distribution of earners over the range of hours and differences in various earners’ responses to changes in taxes and benefits—the comparison is between a tax rate of 55 percent on a wide range of hours or a tax rate of 70 percent on fewer hours.
Working Families Tax Credit vs. Family Credit
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Source: Author’s calculationsWorking Families Tax Credit vs. Family Credit
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Source: Author’s calculationsWorking Families Tax Credit vs. Family Credit
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Source: Author’s calculations13. Another consideration in assessing the incentive effects of WFTC is that even though the WFTC itself is not subject to income tax, it is not well-coordinated with other means-tested benefits. With the withdrawal rate for the Housing Benefit at 65 percent, a family receiving a rent subsidy—as would be typical for those who qualify for WFTC—has a net gain of only 35 percent of the WFTC benefit until the housing subsidy is exhausted. This can be seen in Figure 6, which shows weekly gross earnings and after-tax household income, including the WFTC, unemployment benefits for 0 to 15 hours of work, income tax, national insurance contributions, and a £45 weekly housing subsidy (around the median rent for public housing). The WFTC provides an incentive for a part-time work of 16 hours, but the boost in household income shown in Figure 6 is much smaller than the gross amount of the WFTC in Figure 5—this stems from the elimination of unemployment benefits with receipt of WFTC at 16 hours and the sharp withdrawal rate of the housing benefit, which is tapered precisely as the WFTC kicks in (the housing benefit goes to zero here at 23 hours). Indeed, the replacement rate for this example family—the ratio of welfare benefits received for zero hours to after-tax income at 40 hours with one earner—is nearly 72 percent, but only 53 percent excluding the Housing Benefit. Figure 6 shows that the tax and benefit system provides a subsidy to this household so long as the second earner works part-time or less, after which income net of taxes and benefits falls below gross earnings.
Household Income Before and After Taxes
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Household Income Before and After Taxes
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Household Income Before and After Taxes
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
14. For a jobless household, the WFTC provides a financial incentive for one adult to enter the labor force, but the positive incentives are concentrated entirely at 16 and 30 hours, with extremely high effective tax rates for nearly all other hours. Figure 7 shows the marginal effective tax rates faced by this household; this is the percentage of income from an additional hour of work that is lost to taxes and benefit withdrawals. The tax rate becomes sharply negative at 15 and 29 hours, as working another hour provides WFTC benefits and thus a tax subsidy. It makes little sense to work fewer than 15 hours, since aftertax household income is the same for 3 hours of work as for 15 hours—the 100 percent tax rate results from the one-for-one withdrawal of unemployment benefits for earnings above £10 per week (thus at the third hour). National Insurance at a rate of 10 percent is paid by the first earner starting at 20 hours per week, income tax at the 10 percent rate with 22 hours, and at the 22 percent rate starting with 29 hours. The effective tax rate rises to 64 percent at 24 hours as the 55 percent WFTC taper kicks in on top of income tax and National Insurance. The full-time supplement of the WFTC again provides an incentive for 30 hours of work, but the effective tax rate faced by the first earner then goes back to just under 70 percent from the combination of the WFTC taper, income tax at 22 percent, and National Insurance.
Marginal Effective Tax Rate
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Source: Author’s calculationsMarginal Effective Tax Rate
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Source: Author’s calculationsMarginal Effective Tax Rate
Citation: IMF Staff Country Reports 2000, 106; 10.5089/9781451814149.002.A002
Source: Author’s calculations15. The effects of the WFTC are more complicated for households that qualify for the WFTC but already have one adult in the labor force. Blank, Card, and Robins (1999) refer to such households as “windfall beneficiaries” since they were employed without the benefit enhancement of the WFTC (though possibly not before the previous FC); a costbenefit analysis of a program like the WFTC depends on the number of people who enter the labor force as a result of the benefit compared to the number who get benefits but would have been working anyway. Of course, benefits received by windfall beneficiaries also mean a larger anti-poverty effect, since the additional transfer payments are still going to the working poor even if these households did not need an incentive for one adult to enter the labor force. However, the benefit could lead to a reduction in hours by these workers compared to the case with no tax credit and accompanying benefits withdrawal. This is because the WFTC entails both income and substitution effects for households with one earner already working. In choosing between labor and leisure, the substitution effect comes about from the steep effective tax rate that reduces the reward to work—as discussed above, the reduction in the taper rate over the Family Credit reduces the magnitude of this negative incentive effect on hours but expands its scope.8 But the income effect would also be expected to lead to reduced hours, because leisure is typically considered a “normal” good, the demand for which rises with income. The financial bonus of the WFTC that increases household income would thus be expected to increase the demand for leisure and reduce hours.
16. The WFTC provides the same two-fold disincentive for participation by the second earner. First, the withdrawal of WFTC benefits paid to the household means that the second adult considering even part-time work faces a 55 percent marginal effective tax rate for the first 20 hours and then as high as 75 percent until 30 hours, including income tax and National Insurance (Figure 7). And the income effect again goes in the direction of fewer hours, with the increase in household income from WFTC benefits accrued on the basis of the first earner expected to lead the second partner to work less. Considering the different effects by various demographic groups such as single parents, men in couples, and women in couples, Blundell et. al. (1999) predict an overall net increase in labor force participation of only around 45,000 workers, compared to total U.K. employment of around 27 million.9
17. Even if the net effect on overall labor supply is modest, the WFTC has considerable potential for encouraging labor market participation in households where no adults are currently employed. And this is a worthwhile objective, since labor market inactivity and child poverty in the United Kingdom are concentrated in households with no employed working age adult. Policies aimed at moving at least one of the adults in such households into employment could bring substantial long-term benefits by breaking the intergenerational pattern of joblessness that results from children growing up in households in which neither parent has ever been employed. Moreover, the large rise in the number of recipients and the increased generosity of benefits over the FC gives the possibility of alleviating poverty among the working poor, even if these added benefits are not delivered in a way that strictly increases work incentives.
18. Attenuating the disincentives for second earners and for primary earners who would have worked without the WFTC presents a difficult challenge, since it requires balancing the generosity of the program against its scope and cost. A smaller taper rate would reduce the disincentive via the substitution effect, but this is offset by increased consumption of leisure through the income effect; moreover, a smaller taper rate would extend higher benefits to a larger number of recipients and could thus substantially raise the cost of the program. Two possible avenues for change are:
Use of a proportional rather than flat benefit to provide incentives over a range of hours rather than concentrating the tax subsidy solely at 16 and 30 hours. The WFTC would match a certain share of workers’ earnings subject to a threshold and taper; for example, a 30 percent earnings match would result in an effective tax rate of only 2 percent for a worker who pays 22 percent income tax and contributes to National Insurance at the 10 percent rate.
Improve the coordination of the WFTC with other means-tested welfare benefits, notably the Housing Benefit and Council Tax Benefit (the latter is similar to a property tax). If this were done, a reduction in the gross amount of the WFTC benefit could actually result in increased net income for those at the bottom of the working poor, since this is the income range over which the phaseout of other benefits most reduces the value of the WFTC.
19. A proportional benefit, which is the arrangement used for a similar tax credit in the United States, was specifically rejected by the Taylor report (HM Treasury, 1998) that recommended the expansion of the FC that became the WFTC. The present system and the reluctance to implement a proportional benefit in part reflects the fact that most workers in the United Kingdom do not file end-of-year tax returns, so that the flat rather than proportional benefit reduces the administrative burden in providing benefits—the benefit is extended every six months on the basis of a simple application rather than paid retroactively on the basis of a complete tax return.10 However, as of April 2000 the WFTC will be paid by firms as part of workers’ paychecks rather than by Inland Revenue as is now the case, possibly providing an opportunity to make such a switch without the complication of added income tax returns since firms will have information on hours for at least one worker. A reason for maintaining the 16 hours requirement would be to target the benefit only to those who work enough to acquire enough work experience to have the opportunity for an increasing wage profile. However, this might be an argument in favoring of extending the work requirement back to 24 hours, as was the case before a 1992 reform of the Family Credit. Improved coordination of the WFTC with other benefits could also involve administrative difficulties, since the Housing Benefit and Council Tax are administered at the local level.
National Minimum Wage, and changes to Income Tax and National Insurance
20. Several other measures seek to raise the returns to work for low-income earners, again with the possibly contradictory aims of alleviating poverty and providing an incentive for the currently inactive to move into employment. These include the National Minimum Wage (NMW), introduced in April 1999, and changes to tax rates and the structure of National Insurance contributions being introduced gradually over 1999 to 2001. The National Minimum Wage restores an institution absent in the U.K. since the 1993 abolition of the Wages Council that set wages by industry. The minimum wage is set at £3.60 per hour for adults and £3.20 per hour for youth up to 21 years of age—a relatively low level in comparison with other European countries (about 35 percent of median wages). At introduction, this was expected to cover 8½ percent of labor force and result in a 0.6 percent rise in the wage bill. Although it is too early to undertake a complete examination of the labor market effects of the NMW, there so far appears to have been no appreciable negative employment effects. However, this may reflect the fact that the NMW has been introduced at a time of unusually strong economic expansion. Evidence on the effects of the minimum wage under the Wages Councils from 1975 to 1992 suggests that the system led to wage compression but no adverse effect on employment, though this finding remains controversial.11
21. Changes in taxes and social contributions have focused on increasing take home pay for low income earners and reducing hiring disincentives faced by employers. A reform of the income tax system in April 1999 established a 10 percent tax rate on low income earners, and reduced the basic tax rate by one percentage point to 22 percent effective April 2000. Changes in the structure of National Insurance contributions will phase in over the period 1999 to 2001. These include an increase in the starting point at which employers pay their component of National Insurance, with a zero rate for wages below this lower limit; firms paying wages above the lower limit were previously required to pay National Insurance on wages below it, effectively providing a fix entry fee for workers whose wages rose above the threshold. Administration of payments has also been switched to Inland Revenue so that employers need to deal with only one agency in making tax payments and National Insurance contributions. As of April 2001, the threshold at which individuals contribute to national insurance will be raised to correspond to the income tax exclusion, so that low-income earners will not pay any tax on income below the minimum income threshold.
New Deal for young people and New Deals for other groups
22. The New Deals encompass a number of initiatives that use active labor market programs to help the long-term unemployed move into private sector jobs. Unlike the WFTC, NMW, and tax reforms that provide financial incentives, the New Deals mainly provide assistance and encouragement. Although the target groups do not fully overlap, these might be seen as a complement to the financial incentives of the other programs, since recipients of unemployment and welfare benefits may need these other services to successfully move into employment. Separate New Deals are aimed at a number of groups, including the New Deal for Young People that began in April 1998, and New Deals for single (“lone”) parents, partners of the unemployed, and the disabled. A New Deal is available for those age 25 to 50 who have been unemployed for at least two years, though the benefits are not as extensive as for youth; an enhancement for this New Deal as well as a separate New Deal for long-term unemployed over age 50 is being tested in several regions with the aim of national rollouts in Spring 2000 and 2001. The particulars of each New Deal varies with the target group, but all share common elements such as opportunities for training, subsidized employment, and intensive career advising and job market assistance from a “New Deal Personal Advisor” in the Employment Service.
23. The current flagship program is the New Deal for Young People, which as of November 1999 had enrolled nearly 350,00 young people aged 18 to 24, of whom 145,000 had subsequently found jobs. For those who have collected unemployment benefits for six months, the New Deal provides financial support previously available through the unemployment benefit, but with eligibility for these benefits contingent on participation. After the initial six month period on unemployment, the New Deal begins with a four month “gateway” period of intensive advising and monitoring. Those who are still unemployed after the gateway then choose among four options: (1) full-time education or training; (2) subsidized employment; (3) work for a nonprofit organization; (4) participation in an environmental task force. Remaining passively on the unemployment role is not an option. Failure to cooperate with the Employment Service advisor at any stage can lead to financial sanctions, but participants who cooperate can, in principle, keep renewing any of the four options indefinitely without actually taking an unsubsidized job. Anecdotal evidence suggests that the education and training options are being used by some as shelters through which to avoid employment.
24. Initial results of the New Deal for Young People have been encouraging, although it is too early to say conclusively whether these are due to the program or to the United Kingdom’s strong overall macroeconomic performance and robust job market. More people than anticipated have taken the education and training option rather than the subsidized job option lowering fiscal costs below initial projections—only 16 percent of participants have taken subsidized jobs, versus about 40 percent each for unsubsidized jobs and training. It is still unclear whether the low number of New Dealers going into subsidized jobs has been due to the lack of demand by employers (because the subsidy is not adequate and firms are required to provide subsidized workers with at least one day per week of formal training or education) or a lack of interest in subsidized jobs by the unemployed. A possible explanation is that the high proportion going into education and training reflects the strong job market, since those with skills either do not require the assistance from the New Deal or exit the program within the initial four month gateway, leaving the New Deal options to be utilized by those who are least prepared for employment. This hypothesis is supported by feedback from employers that suggests that many who were hired through the program and subsequently laid off lacked basic employability skills (e.g., reliability, punctuality). This has led to some rethinking by the authorities on the type of training programs that need to be provided, with increased attention now being devoted to “soft skills” as a precursor to specific job-specific education.
25. The New Deal has been found to have reduced long-term youth unemployment by nearly 40 percent, with little adverse effect on the job market prospects of other groups receiving less assistance such as workers older than 25.12 About one-half of the individuals moving from the New Deal into jobs are found to do so as the result of the active labor market assistance, while the other half would have found employment without the extra help. Of course, it is not yet clear how permanent or large the employment effects will eventually be. Gaining skills through education or in-work training will be essential for new labor market entrants to hold onto their jobs and benefit from rising productivity and wage profiles. Bell, Blundell, and Van Reenen (1999) find quite small returns to experience for the low-skilled workers most likely to be aided by the New Deal, suggesting that even with the subsidy to employers, a cyclical reversal could throw the newly-employed out of work before they are able to acquire a more permanent labor market attachment. A complementary policy to the New Deals would be to enhance the quality and availability of intermediate level education, including technical and vocational training, which is most likely to provide the skills necessary for employment of those moving out of welfare.
26. Buoyed by initial success with the New Deal for Youth, the United Kingdom has outlined plans to provide similarly extensive support to the much larger group of long-term unemployed over 25 years. The existing New Deal for Older Workers provides employees with subsidies to be used toward training, arranges tryout opportunities with participating employers, and provides firms with a generous six month hiring subsidy. An enriched New Deal for Older Workers is now available on a voluntary basis in a number of pilot regions; as with the New Deal for Youth, it provides more extensive services from a personal advisor, but without the compulsory nature of the four required options. Expansion of the full-fledged New Deal to the larger group of older long-term unemployed workers will likely prove more challenging and more costly than the New Deal for Young People, which addressed a smaller target group and one likely to be more easily moved into employment. In particular, a six month subsidy might not be sufficient to entice firms into hiring workers with few skills or to keep them on after the subsidy ends.
27. A common feature of the New Deals is the central role of the New Deal Personal Advisor, who acts as counselor, advisor, cheerleader, and, if needed, disciplinarian. As the pool of job-ready workers shrinks, a further challenge for the success of the New Deals will be for the Employment Service to evolve from a role of placing workers into vacancies to enhancing the employability of those who seek to leave welfare. There is anecdotal evidence that the providing the enhanced attention mandated under the New Deal for Youth has stretched the capabilities of the Employment Service, suggesting a possible need for additional resources. Moreover, the role of the Employment Service is likely to become even more central with the future rollout of the “Single Work-Focused Gateway for benefits,” in pilot tests since October 1998, which concentrates both job assistance and welfare benefits at a single point of contact for each individual.
28. Finally, an additional undertaking related to the New Deals are a series of reforms of the disability benefit system that have been ongoing since 1995. Among the steps taken are increases in contribution requirements while in employment before disability coverage becomes available, and a medical test for disability has replaced the previous criterion of “employability,” under which workers in industries undergoing restructuring (e.g., the coal industry in the 1980s) were often put on disability and thus out of the labor force rather than into the unemployment roll. The medical test alone appears to have reduced the rate of entry into disability by around 30 percent. A New Deal for the Disabled complements these measures with additional resources for training and employment subsidies that are meant to help those on disability return to the workforce.
Future plans
29. The 1999 Pre-Budget Report proposes a number of measures to expand the tax and welfare reforms, though the WFTC and New Deal remain at the heart of the policy initiatives.13 Among the proposals are to extend the benefits of the WFTC to families with no children, and combine benefits for families with children into an Integrated Child Credit that would encompass Income Support (the main benefit received by single parents), WFTC, and a Children’s Tax Credit currently slated to go into effect in April 2001 which would provide an additional tax credit for low-income families with children. This would effectively split the WFTC into two components: one received by adults for being in employment, and another meant in support of children; the first component would be labeled as an Employment Credit and extended to all households including those without children. This reorganization does not fundamentally affect the incentives for participation discussed in the preceding sections. An important consideration, however, is that the employment tax credit paid to households with no children could present administrative problems, since it further muddies the distinction between the individual basis for taxation and the household basis for the receipt of benefits. Consultations on these issues are now underway.
D. International Evidence
30. This section examines welfare and labor market reforms in other advanced economies that are most closely related to programs in the United Kingdom, and draws out evidence on the possible outcome of reforms in the United Kingdom. It does not provide a complete discussion of welfare and labor market reforms across the advanced economies but focuses only on cases most relevant for the United Kingdom.
United States
31. The reforms in the United Kingdom most closely mirror those in the United States, with the WFTC, NMW, and New Deals all finding counterparts in U.S. programs. These include the expansion of the in-work tax benefit of the Earned Income Tax Credit, increases in minimum wages, and wholesale revisions of the welfare system in the 1990’s that emphasized personal responsibility and added work requirements for welfare recipients and time limits for the receipt of benefits. These are discussed in turn.
Earned Income Tax Credit
32. The Working Families Tax Credit is similar in many respects to the Earned Income Tax Credit (EITC) in the United States. Like the WFTC, the EITC provides a refundable in-work tax credit for families with children, but the credit is proportional to earnings rather than a flat rate at 16 and 30 hours, providing a 40 percent match for beforetax earnings until the maximum benefit is reached, and then a 20 percent withdrawal rate.14 Since low income wage earners in the United States pay only the 7.65 percent employee share of Social Security tax, the 40 percent match to earnings under the EITC provides a net tax subsidy of 32.35 percent until the maximum is reached; moreover, unlike in the United Kingdom, EITC benefits do not count as income for most means-test programs.
33. Expansions of the EITC have been found to account for as much as 60 percent of the increased employment of single women with children between 1984 and 1996. This evidence is obtained by comparing changes in the labor supply of poor single women with children—the principal group eligible for the EITC—with changes in the labor supply of poor single women with no children, who are not eligible for the benefit. Additional research has focused on the effects on men and women in couples, again comparing the response of those with children who are eligible for EITC to that of those without children. The expansions of EITC have been found to have had a statistically positive effect on the labor force participation of single mothers with children, but with a reduction in hours and labor force participation among married women.15 This suggests that the WFTC is likely to be effective in bringing the currently inactive into the labor force, but the offsetting effects are likely to result in only a small net gain in labor supply and thus output.
34. The design of welfare programs appears to be important, with the in-work benefit having the important advantage that it reduces the stigma attached to receiving welfare, since in-work benefits such as the WFTC and EITC are received as a tax credit rather than a welfare check. In the United States, in-work benefits have been found to have a higher take-up rate than programs that provide subsidies directly to employers—for example, 80 to 86 percent of workers eligible for EITC received the credit in recent years.16 As discussed by Dickert-Conlin and Holtz-Eakin (1999), a further advantage of employee-based subsidies such as the WFTC and EITC is that they better target the population of low-income earners, since eligibility for the benefit is based precisely on having low income. In contrast, employer-based subsidies typically provide firms with incentives to hire particular types of workers or increase employment in targeted occupations or industries, but providing benefits to low-skilled workers is not necessarily the same as to low-income households that are the target of programs with redistributive aims. Moreover, evidence from changes in the U.S. program that supports disabled recipients of welfare suggests that earnings subsidies have a larger favorable effect on labor force participation than reforms that reduce the effective tax rates from benefits withdrawal.17
Increases in the Minimum Wage
35. The experience of the United States suggests that the WFTC will be more effective than the National Minimum Wage as a means by which to reduce poverty.18 Neumark and Wascher (1999) compare the effect of the minimum wage with that of the EITC in increasing earnings for low-income families and moving families above the poverty line. They conclude that the EITC had a more substantial effect on raising the earnings of the lowest-income families, because it led to labor force participation in families with no workers, and these households tended to be relatively low in the income distribution before the reforms. In contrast, the minimum wage provided more assistance to those already in work, who tend to be the working poor just at or below the poverty line rather than at the very bottom. Given the incidence of workless households in the U.K., the experience of the United States thus suggests that future initiatives that seek to reduce poverty might best include refinements of the WFTC rather than increases in the minimum wage.
Changes in the Institutional Structure of Welfare
36. The experience in the United States with welfare reform suggests that the cost of the New Deals could rise considerably as the program expands. In the early 1990’s, welfare reforms were carried out principally by individual states that received waivers from federal welfare guidelines. Probably the best known of these is the pioneering Wisconsin Works program, which had its beginnings as a small pilot program in 1993 and was implemented statewide starting in Spring 1996.19 As with the New Deal for Youth, welfare recipients in Wisconsin program are required to participate in active labor market programs to receive benefits, and are assigned a personal advisor, many of whom were themselves former welfare recipients. A booming state economy with unemployment rates in many locations substantially below the national average has meant that many of those left in welfare need substantial assistance in enhancing their employability. This assistance is delivered in Wisconsin by a more comprehensive system of subsidized and state-run employment than in the New Deal. Welfare recipients in Wisconsin are assessed and placed in categories that reflect their employability, with the generosity of benefits increasing as participants move up through the categories toward private sector employment. Those who are not ready for any employment are provided solely with education and training (with emphasis on “soft skills”), after which they are graduated into work programs run under the rubric of the welfare system, then into subsidized private sector employment, and finally into unsubsidized employment. The program, in principle, includes financial sanctions for non-participation, though in practice this has been left to the discretion of individual advisors and generally enforced in a fairly relaxed manner. As in the United Kingdom, the strong labor market in Wisconsin makes it difficult to distinguish the effects of the program from the macroeconomic environment; welfare caseloads at the end of 1997 were half those of a year earlier, but this was the culmination of a decade-long decline. It is clear, however, that Wisconsin Works is quite expensive, with costs per welfare recipient as much as triple of that before the program. This stems not only from the extensive support including childcare offered under the program and startup costs associated with developing appropriate jobs for participants in the intermediate tier of the system, but also from the strong economy itself, which has left behind only those in need of extensive help. The implication for the New Deals is clear, that costs could rise considerably as the program increasingly serves those in need of extensive assistance, including older workers on long-term unemployment whose skills and labor market attachment are considerably out of date.
37. A key feature that distinguishes welfare reform in the United States from that in the United Kingdom or other countries in Europe is the use of time limits on the receipt of welfare benefits. Welfare reform at the national level in the United States came under the 1996 Personal Responsibility and Work Opportunity Reconciliation Act (PRWORA). This replaced a number of individual federally mandated programs with the single program of Temporary Assistance to Needy Families (TANF). Individuals states were given substantial leeway to adapt welfare programs to local needs, with funding provided by a block transfer from the federal government to states. Under TANF, welfare benefits are seen as temporary, with a five year time limit on the receipt of federally-fund benefits, and shorter limits in states that had such programs in place before 1996. With time limits, welfare benefits become, in effect, an endowment—an asset to be hoarded against an undiversifiable shock that forces a recipient out of employment. Time limits have been found to be effective in reducing welfare caseloads, with families leaving the welfare roll well before benefits are exhausted, suggesting that recipients are forward-looking and seek to preserve part of their benefits endowment for precautionary use.20 However, time limits are controversial, since by their nature they fall most decisively on families with young children, as simple arithmetic means that families with older children are closer to graduating from welfare programs that provide benefits to household with dependent children.
38. The decline in the number of welfare recipients in the United States has been “unprecedented, widespread, and continuous,” with the welfare caseload falling from 14.1 million in January 1993 to 7.3 million by March 1999.21 The difficulty, of course, is in separating out the effects of the reforms from those of the strong macroeconomic environment. The most complete evidence is available for the period before 1996; this suggests that reforms in individual states that received waivers from federal guidelines account for about one-sixth of the increase in employment of single mothers between 1984 and 1996, making it likely that there has been a corresponding reduce in welfare caseloads.22 Other evidence suggests that at least one-third and perhaps as much as one-half to three-quarters of the reduction in welfare caseloads over 1993-96 resulted from the macroeconomic factors of the strong economy and declining unemployment rate. There is less evidence for the period since 1996, but one study suggests that as much as one-third of the decline in welfare caseloads can be attributed to reforms undertaken as part of PRWORA.23
39. Although welfare reform in the United States appears to have reduced caseloads, it is not clear that it has reduced overall poverty. The use of time limits and in-work benefits means that those at the very bottom who are not able to enter employment both do not benefit from the enhancement of the EITC and face the prospect of losing their benefits entirely. The absence of time limits in the United Kingdom implies that the coercive aspect of welfare reform may be less than in the United States, most likely reflecting societal preferences.
Canada
40. Further evidence that welfare recipients respond to programs such as the WFTC that enrich the reward to work is obtained from the results of the Canada Self-Sufficiency Program (SSP). The SSP is an in-work welfare supplement run under an experimental basis in which single parents who have received welfare for at least 12 months are randomly divided in two groups: one in which those who work 30 hours or more receive substantially enhanced benefits for three years, and a second which is given only normal welfare benefits.24 The experimental design thus allows for a comparison of the employment performance of each group that not only controls for common macroeconomic developments, but also has the feature that the group receiving extra benefits shares the observable characteristics of the control group. This improves on the studies of the EITC, which of necessity relied on comparisons between groups with possibly differing characteristics—for example, single parents vs. individuals without children.
41. The results of the SSP strongly confirm that welfare recipients respond to financial incentives that enrich the reward to work, as the employment rate (the flow into employment) doubled for the experimental group compared to those receiving the standard benefits, with a correspondingly larger increase in average income.25 Although the empirical evidence is not entirely comparable, the effect of the SSP in increasing employment appears to be greater than that of the less generous EITC, confirming the expected effect of the larger financial incentive. Moreover, the SSP’s focus on unemployed single parents appears to be successful at targeting only those who most need assistance, with the absence of a statistically significant increase in the duration of unemployment in the experimental group suggesting that the waiting period was long enough so that individuals do not wait a year to receive the greater benefits. Although generous, the cost of SSP so far appears to be somewhat less than expected (and possibly close to self-funding over some periods), as the success in generating employment has led to increased tax revenues that offset program expenditures. Finally, an SSP+ program that provides some individuals with additional services such as employment counseling and job search assistance has been found to have a small additional effect in increasing employment and earnings.
42. The results of the Self-Sufficiency Program in Canada provide substantial encouragement for the WFTC, though there are important differences between the two programs. In particular, the SSP is more narrowly targeted with a focus only on single parents and a 1 year waiting period for benefits that prevents those who are already employed from receiving assistance. Adding similar restrictions to the WFTC would eliminate the effect by which windfall recipients who are already in jobs reduce their hours in response to the benefit; this would also lower the cost of the WFTC. On the other hand, such a change would favor welfare recipients over the working poor, who have nearly the same income and job prospects, and raise thus serious questions of horizontal equity, and would take away from the redistributive component of the WFTC. Nonetheless, if future changes are required to WFTC—for example, to reduce the cost—the SSP points to one possible direction for such efforts.
Other Countries
43. In contrast to the United Kingdom, Canada, and the United States, reforms in many other countries have involved reductions in benefits given to the inactive as a means to encourage labor market participation. Many of these countries, including Denmark, the Netherlands, and New Zealand undertook reforms in response to economic difficulties, and as a necessity concentrated on cost-saving reforms rather than in-work benefits that increase the reward to working. In contrast, the United Kingdom has had the luxury of being able to expand benefits for the employed rather than cut those for the inactive. Evidence on the difference between the two approaches is discussed below.
Denmark
44. Welfare reform in Denmark took place in the context of a macroeconomic stabilization in the early 1980’s, which included a change in the exchange rate regime, fiscal consolidation, and incomes policies aimed at improving competitiveness.26 Welfare and labor market reforms began in the early 1990’s when the unemployment rate reached double digits—above 12 percent in 1993. To motivate the inactive, the duration of unemployment benefits was reduced from 9 years to 5 years in 1993, and participation in active labor market programs made compulsory after 2 years out of work; agreements among social partners in 1994 and 1995 led to further reductions in benefits and the strengthening of active labor market programs. This was combined with incentives for early retirement from 1992-96 that sought to free up jobs for new workers, and rules that increased eligibility for work sabbaticals for child care, education, and personal enrichment, all of which served to reduce participation. The unemployment rate has fallen by nearly half since 1993 as growth recovered, leading to a partial reversal of some measures aimed at reducing participation. Welfare reforms have clearly played a role, but there is not yet definitive evidence that distinguishes the effects of reforms from the contribution of the cyclical recovery.
New Zealand
45. Better evidence on this point is available for New Zealand, which undertook extensive reforms to product and labor markets starting in the early 1980’s, in response to economic stagnation and declining competitiveness. As discussed by Evans and Wilkinson (1996), the first wave of reforms centered on efforts to improve competition among domestic firms by removing import protection and industrial subsidies, with labor market reforms announced at the end of 1990 and taking effect in the first half of 1991. New Zealand’s approach to welfare reform focused mainly on reducing benefits with the aim of providing a lower replacement ratio and thus increased work incentives. Measures taken in New Zealand to tighten eligibility for benefits include an increase in the minimum age for the receipt of welfare from 16 to 18, an increase in the waiting period before receipt of unemployment benefits from 6 weeks to 52 weeks, and gradual increases in the retirement age. Benefits were reduced by as much as 25 percent for single welfare recipients, but by much less for married couples—only 3 percent for a married couple with no children. Of considerable interest for the reforms in the United Kingdom is that a $100 reduction in the average value of weekly benefits is found to have led to an 11.3 percent increase in the labor force participation rate, nearly twice the effect of a $100 increase in earnings for full-time work, which led to a 6.4 percent increase.27 The increase in the age of eligibility for retirement benefits is found to have had a substantial effect in encouraging participation, accounting for nearly 1 percentage point of the 3.15 percent increase in participation from 1990 to 1995, with the decline in benefits accounting for 2.74 percentage points (these were then somewhat offset by reductions in benefits available to full-time workers that reduced participation). This is not to say that the opposite course taken by the United Kingdom in enhancing the value of employment will not work, but the experience of New Zealand suggests that this approach likely sacrifices some efficiency in terms of an increased labor force response. Maloney also finds that eliminating unemployment benefits for 16 and 17 year olds led to a sharp increase in the take-up of education for this age group rather than higher employment; this corresponds with the large share taking up the education and training option under the New Deal for Young People.
Netherlands
46. Reforms in the Netherlands have been successful in creating jobs, but not in lowering unemployment. Changes in the Netherlands began in the face of the 1982 recession, and were of necessity far more comprehensive than in the United Kingdom, including not only welfare and labor market reforms, but also major changes in the macroeconomic framework such as fiscal consolidation and the abandonment of an active monetary policy in favor of a link to the deutsche mark.28 Labor market reforms in the Netherlands included cuts in the minimum wage and unemployment benefits, but also placed an important emphasis on coordination between employers and workers to bring about wage moderation. Labor market regulations were relaxed to allow for increased use of part-time employment, and older workers were encouraged to retire (often under the guise of disability) rather than to compete for jobs with less experienced workers. The results of these policies can be seen in Figures 1 to 3: the unemployment rate at the end of 1999 was the lowest of the advanced economies and employment growth has been quite strong (Figures 1 and 2), but labor force participation is above only that of Spain. Indeed, Watson et. al (1999) conclude that despite a strong performance in terms of employment creation, once the rise of disability is taken into account, the Netherlands has not performed particularly well in terms of lowered unemployment. In a sense, the aim in the United Kingdom is for the opposite outcome, for reduced unemployment among primary earners such as prime-aged men, even if this means only a small net gain in employment. In part, this reflects the robust economy in the United Kingdom, since the strong labor market appears to be generating jobs without government intervention. The experience of the Netherlands may thus not hold lessons for the United Kingdom, but a comparison of the two approaches will be useful for other advanced economies contemplating welfare and labor market reforms.
Sweden
47. Sweden presents an interesting comparison with the United Kingdom in the possibilities of encouraging labor force participation, especially by female second earners. As shown in Figures 3 and 4, labor force participation in Sweden is only slightly higher than in the United Kingdom, but the government sector comprises a far larger share of the workforce in Sweden—substantially higher than in any advanced country other than Denmark. Rosen (1996) shows that employment by local governments accounts for essentially all employment growth in Sweden since the 1960’s, with most of this comprising women taking jobs as social service providers employed by local governments, in positions such as day care providers or elder care. These positions are made possible by generous child care subsidies that enable women to enter the labor force in the first place. However, Rosen points out that Sweden has effectively brought into the market economy activities that would otherwise have taken place without cost, creating a sort of cross-hauling: person 1 is employed to take care of person 2’s elderly parents, while person 2 minds the child of person 1. This commercialization of family care is a matter of societal preferences, but one with substantial economic consequences, since as much as half of government expenditure in Sweden is devoted to supporting these activities, requiring substantially higher tax rates than would otherwise be the case. There is a deadweight loss involved with government taxation, so that the cost to society of paying for these service providers is larger than the wages they receive. The loss from “excess” provision of paid family services is found to be quite substantial in Sweden—as much as $4,000 per child (in nominal terms at the 1996 exchange rate).
48. An implication of this finding for the United Kingdom relates to the generous childcare subsidy offered as part of the WFTC. The subsidy in the WFTC is available only to parents whose children are cared for by licensed providers, but the requirements for obtaining a license are, in principle, fairly straightforward. The availability of the subsidy might thus be expected to encourage current providers of unpaid childcare—parents or grandparents taking care of their own children—to formalize the arrangement and take in additional children. A high take up rate of the child care subsidy would allow for additional labor force participation as sought by the WFTC, but the economic benefits from this would be dissipated to the extent that the resulting higher fiscal costs of the WFTC require higher tax rates than would otherwise be the case and thus entails a deadweight loss to society. Moreover, the approach to child care in the United Kingdom is purely market-based, with no provisions to date for encouraging increased supply of child care other than the subsidy to parents. It will thus be important to observe the take-up of the child care subsidy and subsequent changes in the market for childcare—some possibly induced by the generosity of the benefit itself—in order to fully assess the fiscal consequences of the WFTC.
E. Conclusions and Implications
49. This comparison of welfare reform in the United Kingdom with similar efforts in other countries highlights the importance of considering the differing incentive effects of welfare programs on various groups, as benefits given to some individuals can lead to decreased participation by others. This suggests an important role for measures that carefully target benefits to the intended recipients, including the use of waiting periods and hours requirements for benefits. The targeting of WFTC is fairly imprecise, with the provision of most benefits at 16 hours meaning that benefits go to some who would have worked two days per week without the incentive. With the New Deals, however, the 6 month waiting period for youth and the 2 year wait for older workers appear to be sufficiently lengthy to screen out those workers who would have gone back into jobs without help. Any future cyclical slowdown in the U.K. will create short-term unemployed with different needs than the long-term unemployed who are the focus of welfare reform, and it will be necessary to ensure that programs are able to separate the two groups so that benefits to the cyclically unemployed do not inadvertently provide incentives for the long-term inactive to remain out of the labor force.
50. An important question still to be resolved is the relative effectiveness of positive incentives to work versus measures that reduce the benefits given to the inactive. The experience of the United States and Canada shows that increasing the reward to work has a favorable effect on labor force participation, but evidence from New Zealand suggests that the stick is possibly more potent than the carrot. It remains to be seen the extent to which either result generalizes to other countries.
51. Overall, the experience of other countries, especially the EITC in the United States and the SSP in Canada, points to the great promise of the WFTC in providing an incentive for one adult in jobless households to enter employment and thus alleviating poverty among those who take advantage of the benefit. But the international evidence likewise highlights the main pitfall, that improvements in net labor supply and thus macroeconomic gains in output will be fairly small in the short run. Economy-wide productivity could actually fall as a result of welfare reform, as those brought into employment will have skill levels below current workers, while unemployment rates could rise temporarily, as the currently inactive reenter the labor force but take some time before their job search is successful. And startup costs could be substantial, especially as the New Deal is extended to larger groups.
52. In conclusion, recent welfare and labor market reforms in the United Kingdom appear to hold much promise. In the near term, welfare reform could play an important role in arresting the trend toward increased income inequality by boosting the rewards to working at the low end of the earnings distribution. The real gains, however, will be measured over a longer horizon, first as the new workers acquire skills and increase their productivity and thus wages and incomes, and eventually, as the children and grandchildren of current welfare recipients escape from the intergenerational cycle of poverty and dependence.
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Bloom, Dan, 1999. “Welfare Time Limits: An Interim Report Card,” Manpower Demonstration Corporation mimeo, April.
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Prepared by Phillip Swagel.
See Berman and Machin (1999) and World Economic Outlook (1997).
HM Treasury (1997).
Figures taken from HM Treasury (1 97, 1999).
See France, Selected Issues Paper, SM/98/132, December 1998.
For the tax year starting April 2000, the WFTC consists of £5 3.15 per week for a household with an adult working 16 hours, an additional £11.25 for working 30 hours, and another £20-25 per child (the precise amount varies with the age of each child). The child care subsidy reimburses 70 percent of weekly expenses up to £100 for one child or £150 for two or more children. The income threshold above which benefits are reduced is £91.45 per week after income tax and National Insurance contributions.
The base amount of the FC from 1999 has been adjusted to account for inflation and thus make the amount comparable with the 2000-01 WFTC benefit. See Blundell et. al. (1999) and Dilnot and McCrae (1999) for a complete comparison of WFTC and FC.
Before introduction of the WFTC, 5 percent of working families—around 750,000—faced marginal effective tax rates of 70 percent or more; this has now been reduced to around 250,000 families, though many of these still face marginal effective tax rates of 60 percent or more from the combination of the WFTC, income tax, and National Insurance.
Blundell et. al. (1999) use data on 50,000 households from the British Family Resources Survey to estimate structural equations that capture the response of different groups to changes in tax rates and benefits, and then use the estimated relationships in simulations that predict the effect of the WFTC. The effect on single parents and unemployed men in couples is strongly positive in terms of labor force participation, but of households eligible for WFTC, these two groups together are only about half as numerous as couples with the man in employment, for which the WFTC provides disincentives for both the first earner already in the workforce and for potential or existing second earners.
See Holtzblatt and Liebman (1998) for a discussion of administrative issues relating to the WFTC and other in-work benefits.
See Institute for Fiscal Studies (2000) for a complete discussion and analysis of current plans, including those not involving welfare and labor markets.
In 1999, a household with one child receives the maximum benefit of $2,312 for earnings of $6,800 to $12,500; the 20 percent withdrawal rate means that the credit reaches zero at an income of $26,928.
See Scholz (1994) and Meyer and Rosenbaum (1999).
A substantial and controversial literature (not surveyed in this paper) examines the effects on employment of recent increases in the minimum wage in the United States. There is no serious dispute that there is some level at which a minimum wage would be high enough to have an adverse effect on employment, but substantial disagreement as to whether the increases in the United States have met this threshold. As mentioned above, this issue is similarly controversial in the United Kingdom, where the minimum wage is set a fairly low level.
See Kaplan (1998) among many others for a complete discussion of Wisconsin Works and comparison with other state waiver programs.
See Bloom (1999) and Grogger and Michalopoulos (1999).
See Council of Economic Advisors (1999), Ziliak et. al. (1997), and Figlio and Ziliak (1998).
See Canada Selected Issues Paper, SM/99/14, March 1999, for a comprehensive discussion of Canada’s social welfare system.
See Barrell and Genre (1999) for a comprehensive discussion.
See Maloney (1997).
See Watson et. al. (1999) for an extensive review of the experience of the Netherlands, and Hartog (1999) for evidence focused on labor market reforms.
