ECON 3240 Session 3. Instructor: Dr. David K. Lee

Transcription

1 ECON 3240 Session 3 Instructor: Dr. David K. Lee Department of Economics York University Topic: Labor Supply and Public Policy: Readings: Ch 3 Please read the related topics from other microeconomics textbooks for your own benefits. This handout is not perfect. You have to make your own note from the lecture. Topics to be discussed: Income Maintenance Schemes : Demogrant Welfare Programs Negative Income Tax Wage Subsidy Earned Income Tax Credit Unemployment Insurance Workers Compensation Childcare Subsidies Income Maintenance Schemes (IMS) Designed to help financial hardship of low incomes. Canada/Quebec Pension Plan, Old Age Security, Employment Insurance, Federal Chid Tax Benefits, Social Assistance, Worker s Compensation, etc. Governments in Canada spend over 10 percent of GDP on IMS. No single program can address the multiple reasons for low income Problem of adverse work incentives. Universal Programs vs. Targeted Programs Universal Programs Say, z a well-defined poverty line, then make t i =z, no matter what their income y i, where y i < z. Administratively simple Everyone receives the same transfer regardless of income Problem 1: Expensive Problem 2: Many benefits leaking to nonpoor. Targeted Programs t i = z-y i. Cheaper method assuming no administrative costs (which are in fact very high). Individuals are given exactly enough of a transfer to reach the poverty line, z. Only those below poverty line would receive transfer Creates a disincentive to earn income and, hence, may cause individuals to reduce work effort Need to design minimize work disincentive Permanent or Transitory? Employment insurance: Designed to provide temporary income support in the case of job loss. Workers compensation: Temporary income support for a work place-injury. Page 1 of 12

2 For permanent injuries or disabilities: Disability benefits under CPP. For permanent job losses, welfare payments once exhausted EI. For helping re-integration into the labour market: child care benefits for mothers, or job training programs. In general, shortage of work hours is mainly associated with the loss of transitory income (needs transitory type policy) But low wage rate, on the other hand, may represent permanent low income (needs permanent type policy) Problem: Difficult to isolate permanent from transitory Static Partial Equilibrium: Demogrant: Lump sum transfer or income grant (universal) to a specific demographic Old Age Security (OAS): Providing monthly benefits to people aged 65 and over Previous Family Allowance Program Work Incentive Effects of a Lump Sum Demogrant M E1 Ed E0 Demogrant T At E1 the working hours are not altered lower U. At Ed the working hours are reduced higher U. If leisure is normal good, less work will be the result. No substitution effect Work incentives are reduced Pure leisure-inducing income effect Increase in income is less than the amount of demogrant (all or a portion of the demogrant is used to buy leisure) Welfare, or Social Assistance Administered by the provinces Financed partly by the federal government (about 50 percent under the Canada Page 2 of 12

3 Health and Social Transfer program) Benefits depend on: needs of the family, assets, other sources of income M E0 Ew Welfare benefit T Potential income constraint is horizontal at Yw (the welfare payment). Strong incentive to move to corner solution To improve work incentive of welfare programs: Reduce the welfare benefit Increase the wage rate Reduce the implicit tax (clawback) Change the preference Reduce the welfare benefit: M E0 Ew Welfare benefit T No incentive to go on welfare since the individual is already maximizing at E 0. It may be successful in reducing the number of people on welfare. But it may deny welfare to those in need or provide inadequate income support to the unemployable. Page 3 of 12

4 Increase Wage Rate: wage rate to encourage individuals to voluntarily leave Welfare increases incentive to work Wage increases can be done through: training job information mobility government wage subsidy institutional pressure (unionization, minimum wage) Union and minimum may cause loss of jobs. Costly Reduce the Implicit Tax Suppose that the lump-sum welfare of $100 provided by government and wage rate is $10 per hour and 100% negative tax policy applied for welfare recipients, or government deduct every dollar earned by the recipients. 100 Under this policy the recipients have no incentive to work. Now the government changes the policy: lump-sum pay of $50 and negative tax of 50% applied for every dollar earned above $50 up to the maximum of $100. Page 4 of 12

5 The income constraint line with $100 lump-sum pay with 100% negative tax: M=10(24-h) where h h14 and M=100 where h 14. Income constraint with $50 with 50% negative tax with the income above $50 M= 10(1-0.5)(24-h)+50 = 170-5h when M 100 and M=10(24-h) when M 100. Tax reduction requiring recipients to give up only a portion of welfare if they have earned income increases incentive to work Change Preferences Alter preferences away from welfare flattens the indifference curve Negative Income Tax Negative income tax or guaranteed annual income plans involve: - 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 Y = G + (1 - t)e Where: G = Guaranteed Income t = Tax rate E = Earnings Page 5 of 12

6 Slope = w Slope = (1-t)w Wage Subsidy Does wage subsidy increase work incentive? As with a wage increase, a subsidy rotates the income constraint upward Higher income means higher purchasing power including leisure. And buy more leisure if it is a normal good. Higher income also means the OC for leisure is now increased. Substitution effect and income effect work in opposite directions: ambiguous incentives Wage Subsidy Effects Theoretically 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 Page 6 of 12

7 Wage Subsidy vs. Negative Income Tax Earned Income Tax Credit An new income-tested wage subsidy program used in both US and Canada to reduce the cost associated with the pure wage subsidy programs It is a refundable tax credit or subsidy that is paid irrespective of other income taxes paid by the individuals c d a b Page 7 of 12

8 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 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 Employment Insurance (Worked Example) Assume: 60 percent of weekly pay for maximum of 20 weeks, and requires a minimum of 14 weeks of employment with 1 year time horizon (52 weeks). Assume weekly earning is $ Slope=(1-0.6)*W = 40 A B Slope = W=100 C Full benefit = 0.6*20*W=0.6*20*100= 1200 D F L Income constraint without UI: Y=100(52-L) = h where Y=annual income, L= #week of leisure. Income with UI when L=38: Y = (52-38)W + (0.6*20)*W = 2600 Or in general Y=(52-L)W+0.6*20W where L 20. (if L=20, Y=4400) And Y=(52-L) W+ 0.6*L*W= 52W-WL+0.6LW = 52W+0.4WL AF: income constraint without UI. ABCDF: with UI. DF: Worker work less than 14 weeks. Page 8 of 12

9 Disability Payments and Worker s Compensation Ho: Hours of leisure without disability Hp: with partial disability Hf: with full disability, etc. Compensation: No Incentive to Return to Work Page 9 of 12

10 Childcare: Impact on Budget Constraint Page 10 of 12

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