The Labor Supply Incentive Effects of Social Welfare Programs Aimed at Low-Income Households - Essay Example

? The Labor Supply Incentive Effects of Social Welfare Programs Aimed at Low Income Households Table of Contents Table of Contents 2 1.Introduction 3 2.Economic Theory 4 3.Empirical Evidence 5 4.Conclusion 7 References 8 1. Introduction The major issues arising from the welfare reform are the reduction in wages and increase in unemployment. As a result of this ‘displacement impact’ of the welfare reforms being large, the subsequent increase in labor supply must be large. This paper analyzes the possible impact of welfare reform over labor supply incentives. For so many years, the US has been involved in welfare reforms that any dating of the beginning of welfare reforms is irrational. In many ways, the welfare reforms in the past two decades have given rise to labor supply. The life of the people relying on welfare reforms has become more difficult due to the work requirements for welfare recipients, the decline in the real value of welfare benefits, and the sanctions for not complying with the requirements imposed by the state for welfare recipients, such like the work related participation activities held mandatory for the welfare recipients. Due to which, people would be encouraged to opt for being in or entering in to the labor force rather than leaving or applying for the social welfare programs. Such decisions or choices are based on the perceived toughness of the state’s welfare program and thereby, are influenced by the state’s rhetoric in relation to the welfare reform and not just enforced by the requirements of the law of the state. However, the sanctions imposed on the welfare recipients may simply compel them to seek work by throwing them off the welfare rolls. Also, the time limitations of the number of years for which a particular welfare recipient can benefit from the social welfare program may subsequently lift some welfare recipients off the welfare program. By encouraging people towards work by imposing work requirements for welfare recipients, by providing monetary incentives to the welfare recipients for working, and by offering ‘welfare to work’ programs, the labor supply can be increased. 2. Economic Theory There are three vital elements of any optimal economic analysis, which are: the precise evaluation of response elasticities, comprehensive specification of the distribution of income, as well as some perspective of the social welfare weights. The former two elements are positive and can be determined through thoughtful evidence based analysis. On the other hand, the last element mentioned above is normative and thus, something at which perspectives may differ. Now, we will discuss that how these elements will operate in the structure of earnings and taxation. In relation to labor supply responses, an important distinction lies between the intensive and extensive margins of labor supply. The studies on optimal taxation investigate the outcomes for tax design (Diamond 1980; Saez 2002; Laroque 2005). When the people are permitted to respond to the variations in the tax schedule by selecting to work or not, and how hard to work, then the schedule of optimal tax can vary to a great extent. Particularly, when this choice of employment becomes comparatively more significant, then the rates of optimal marginal tax can reduce dramatically, even to a negative value, for the people with low earnings capacity. According to Brewer, Saez, and Shephard (2010), an impelling inference is that if the state government commends redistribution then the workers having low income should be given an earnings subsidy since the participation tax rate for low earnings would be negative. Therefore, the extensive model signifies that work contingent credits or earnings subsides, such like the working tax credit or the earned income tax credit, should be the constituent of an optimal tax system, which is in acute contrast to the intensive model. This is among the vital lessons from the new optimal tax design. Due to the large extensive elasticity, the effect of the falling social weights can be turned around signifying a role for earned income tax credits and a higher transfer to the worker with low wages. Another vital concern in tax design is that how the responses vary among people of distinct characteristics. In general, the tax rates will be lower on the types of people with more elastic responses unless there is a profound redistributive explanation to do otherwise. At last, the measure of income uncertainty and of inequality will also be an important concern for earning tax design. During the previous three decades or even more, a variation in the nature of earnings risks and a sharp rise in earnings inequalities have been witnessed. The redistributive aspect of the earnings tax and benefit system partially serves as an assurance to earnings risks. The balance between the work incentives and the inequality becomes difficult to conform to with the change in the nature of these risks and the growth in the underlying inequality. Developing an efficient design for the earnings tax and benefits system in a way that it attains the appropriate distributional objectives becomes important more than ever. 3. Empirical Evidence The studies on determining the reduced-form effect of the changes in the policy of employment and earnings is surpassing modest as well. Yelowitz (1995) employed the expansion of Medicaid in various states and in distinct age groups of children in order to determine their effect on employment and deduced that those expansions have a positive impact over the rates of employment. Various studies have also been carried out on policy impact related to the effect of the EITC on labor supply (Eissa and Liebman, 1996; Eissa and Hoynes, 1998). The findings illustrate that the EITC causes the employment probabilities to increase for single mothers but has no net impact on their working hours, in case they are working. This complies with the concept that labor supply is encouraged in amateur workers who have just started working but that the tax back area of program causes the labor supply to decrease enough to negate the impact among workers. According to Meyer and Rosenbaum (2001), the impact of EITC on single mother is significantly positive in relation to employment probabilities. Eissa-Hoynes in their research on the impact of EITC on married men and women found that the EITC resulted in the rise of employment probabilities among married men whereas it reduced the employment probabilities among married women and it also reduced the working hours of both the working men and the working women. These findings for married women may be due to the reason that most of the selected population for the study was located in the area of tax-back where the men are able to earn significant income for their families and the contribution by the working wives may be considered as insignificant, even at the first dollar. Moreover, the findings regarding the working hours of working men, mentioned above, may also be due to the same tax-back area. Numerous studies have been carried out in relation to the impact of 1996 welfare legislation that introduced the Temporary Assistance for Needy Families (TANF) program by transforming the AFDC program under the Personal Responsibility and Work Opportunity Reconciliation Act (PRWORA), which established work requirements, time limits and devolved responsibility and cut off grant funding to the states (Moffitt, 2002). Also, there were numerous researches on the ‘waiver’ programs just before 1996 which enabled the states to test the programs that were found to be similar to the later national PRWORA legislation, in most of the cases. Assessment of these waiver programs was possibly performed since various states tested various types of welfare programs at different periods of time that furnished the change in the policy, due to which the effects on labor supply could be determined. Nevertheless, it was hard to assess the 1996 legislation that was imposed nation-wide and all the states were compelled to comply with its basic provisions. Hence, there was no discrepancy across the states in the overall nature of the program. Subsequently, the difference-in-difference methodological approaches have been generally employed for finding the impact of TANF program. According to Ellwood (2000) and Schoeni and Blank (2000), the employment of these techniques is problematic, in particular, when other reforms like EITC were appearing almost simultaneously, and when economic trends and business cycle were taking place influencing various groups differently. The estimates of overall reform effects obtained through experiments could be biased. It had been found that the evaluated impact of TANF is, in general, was positive over employment and earnings however this is not always true. Moreover, the effects of TANF program often cannot be disconnected from the impacts of other policy shifts happening at the same time, as noted by Ellwood (2000). Ellwood (2000) deduced that these hardships are critical enough to separate the effects of EITC and to maintain the uncertainty within the economy. Two other studies, Schoeni and Blank (2000) and McKernan, Lerman, Pindus and Valente (2000), also employed the difference-in-difference method, one of them concluded that TANF has raised employment whereas the other one negated this conclusion and found rather to have influenced the family income, earnings and AFDC participation. The findings of these two studies are different, may be, due to the use of different control groups in their research methodologies. Therefore, the evidence provided in these studies reflects some sort of TANF impact in the desired direction however the limited number of studies and issues in the statistical analysis make the conclusion quite uncertain. 4. Conclusion The effects of welfare programs in relation to labor supply and other work incentive have been a core issue in the economic research, for a long period of time. Also, work has been an area of rising concern in the policy reforms of the USA, deducing with various major policy changes in the 1990s that were subjected to increase the levels of employment and earnings of the welfare recipients and other such people in need. This paper examines the theoretical and empirical literature available in relation to this subject and finds that much has to be done to acquire a complete understanding of welfare programs as such. An important issue remains to be the identification of many issues associated with the optimal levels of the elements of the welfare programs and the desirability of labor supply impacts among the people in separate areas of the income distribution. Recent policy initiatives in the subject of time limits, work requirements and other topics need to be studied further due to the dynamicity within the models of labor supply response. Further research is also required in the area of the proper combination of intricate multi-program environment in the US. The paper primarily uses the studies of Dorion (2004), Meyer and Rosenbaum (2001) and Moffitt (2002) along with various other studies as an illustration of the empirical evidence to use economic theory for describing the labor supply incentive effects of social welfare programs targeted towards low income households. The paper endeavored to infer on the empirical evidence when ever deemed possible in the analysis of the welfare reforms that have been placed in the United States. Throughout the study, the paper deduced a vital role for labor supply responses at the extensive and intensive margins, both of which are significant however they vary with respect to age, education, gender and family composition. It is important to target tax credit to low income households. Employment and earnings were significantly increased from these welfare reforms. References Brewer, M., E. Saez, and A. Shephard (2010) ‘Optimal household labor income tax and transfer programs,’ in Dimensions of Tax Design: The Mirrlees Review, Oxford: Oxford University Press for Institute for Fiscal Studies. Diamond, P. (1980) ‘Income taxation with fixed hours of work,’ Journal of Public Economics, 13, 101–10. Dorion (2004) `Welfare Reform and the Labour Supply of Lone Parents in Australia: A Natural Experiment Approach', Economic Record, 80(249) pp.157{176. Eissa, N., and H. Hoynes (1998) "The earned income tax credit and the labor supply of married couples", Working Paper 6856. Cambridge: National Bureau of Economic Research. Eissa, N., and J. Liebman (1996) "Labor supply response to the earned income tax credit", Quarterly Journal of Economics, 11: 605-637. Ellwood, D. (2000) "The impact of the earned income tax credit and social policy reforms on work, marriage, and living arrangements", National Tax Journal, 53: 1063-1105. Laroque,G. (2005) ‘Income maintenance and labor force participation,’ Econometrica, 73, 341–76 McKernan, S.M., R. Lerman, N. Pindus and J. Valente (2000) "The relationship between metropolitan and non-metropolitan locations, changing welfare policies, and the employment of single mothers", Washington: Mimeo. Meyer, B.D., and D.T. Rosenbaum (2001) "Welfare, the earned income tax credit, and the labor supply of single mothers", Quarterly Journal of Economics, 116: 1063-1114. Moffitt (2002) `Welfare programs and labor supply', Handbook of Public Economics Volume 4. Saez, E. (2002) ‘Optimal income transfer programs: intensive versus extensive labor supply responses,’ Quarterly Journal of Economics 117(3), 1039–73. Schoeni, R., and R.M. Blank (2000) "What has welfare reform accomplished? Impacts on welfare participation, employment, income, poverty, and family structure", Working Paper 7627, Cambridge: National Bureau of Economic Research. Yelowitz, A. (1995) "The Medicaid notch, labor supply, and welfare participation: evidence from eligibility expansions", Quarterly Journal of Economics, 105: 909-940. Read More