Is welfare dependence optimal for whom – part 6: mandatory work requirements and labour supply

A mechanism for reducing welfare programme entries while increasing welfare exits is work requirements. These minimum hours can be spent working part time, in study and training, work preparation and job search assistance or volunteering.

A work requirement is a screening device removes any advantage of moving on to welfare in terms of more leisure time. U.S. welfare reform side-stepped the problem of programme entry with lifetime time limits on eligibility and work requirements making entry unrewarding. A lifetime time limit on eligibility also reduces inflow in to welfare receipt because workers have an incentive to bank their eligibility to hard time arise. Different work tests and abatement regimes that vary with circumstances on length of time on the benefit also increase exits without increasing entry.

Most work requirement schemes have waivers for those unable to work. Work requirements make welfare receipt less attractive and more hassle while not making welfare receipt any more or any less financially rewarding to those in work.

The gap between working and welfare receipt is larger because of the work requirements make the benefit less pleasant but no additional cash payments are made to encourage welfare programme entry.

Most welfare systems experiment with policy options to separate those who can work from the truly needy. Changes in financial incentives arising from abatement regimes, benefit levels and benefit durations are welfare reform workhorses. The clear-cut labour supply effects of work requirements are a useful contrast to the ambiguity of labour supply changes when benefit levels and abatement regimes change.

Figure 1 illustrates work requirements by introducing a minimum working hours requirement, which eliminates part of the budget constraint before the minimum hours. Work requirements combine a negative tied transfer – an obligation to work – with cash to induce those with a higher ability to work to self-select and opt out of the welfare system entirely.

Figure 1: The labour supply effects of mandatory work requirements as a condition of welfare benefit receipt

mandatory work requirements for welfare benefits

Arrows 1, 2 and 3 in Figure 1 represent possible labour supply responses to work requirements which lead to an increase in the hours worked by different types of workers, some moving to working part-time and others not working at all.

Arrow 1 shows some beneficiaries who are marginal workers increasing their hours from zero to the minimum. Other marginal workers will work more but no longer work enough hours to qualify for a benefit as shown by arrow 2.

This increase in labour supply, as shown by arrows 1 and 2 in Figure 1, is to be expected because a work requirement eliminates welfare benefits altogether over a certain range.

Welfare payments reduce the supply of labour unambiguously so reducing the generosity of welfare reduces the disincentives to supply labour.

A work requirement also reduces entry into and increases exit from the welfare system by more persistent workers as shown by arrow 3 in Figure 1.

This welfare exit effect and entry deterrence arises from the relative non-financial rewards of working and not working have changed in favour of staying in full-time and semi-work for persistent workers temporarily on a welfare benefit.

Persistent workers gain from anticipating the onerous nature of work requirements and searching more intensively for jobs which are more stable and enduring.

These job seekers may reduce their asking wage to win a lower paid but steadier job. Seasonal and temporary jobs will be less attractive if there are work requirements.

The incentive to cycle between the benefit and part-time and full-time work including seasonal and temporary jobs are reduce because work requirements make welfare receipt more onerous.

Those job seekers with fewer outside of the workforce obligations such as young children are the most likely to move to (stable) full-time work because of work requirements.

Those with more extensive outside commitments such as pre-schoolers work the minimum hours or make other arrangements because they now fail to qualify for welfare.

A work requirement unambiguously increases net labour supply and reduces the number of people relying on the welfare system now and into the future.

In contrast to abatement regime reforms, no one enters the welfare system as a new benefit claimant as the result of introducing work requirements.

The number of people working increase and some leave welfare rather than comply with the work programmes. Work requirements make welfare receipt unambiguously less attractive and will close the gap between earning full-time wages and the net rewards of not working or part-time work and partial benefit receipt.

The 60 per cent reduction in welfare caseloads that followed the 1996 federal welfare reform in the USA that introduced work requirement and time limits on a national basis.
Welfare Caseloads have declined since 1996

The subsequent declines in welfare participation rates and gains in employment were largest among the single mothers previously thought to be most disadvantaged: young (ages 18-29), mothers with children aged under seven, high school drop-outs, and black and Hispanic mothers. These low-skilled single mothers who were thought to face the greatest barriers to employment. Blank (2002) found that:

At the same time as major changes in program structure occurred during the 1990s, there were also stunning changes in behaviour. Strong adjectives are appropriate to describe these behavioural changes.

Nobody of any political persuasion-predicted or would have believed possible the magnitude of change that occurred in the behaviour of low-income single-parent families over this decade.

The blogs so far

part-one-the-labour-leisure-trade-off-and-the-rewards-for-working

part-two-the-labour-supply-effects-of-welfare-benefit-abatement-rate-changes

part-3-abatement-free-income-thresholds-and-labour-supply

part-4-in-work-tax-credits-and-labour-supply

part-5-higher-abatement-rates-and-labour-supply

part-6-mandatory-work-requirements-and-labour-supply

part-7-the-role-of-tagging-in-welfare-benefits-system

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Is welfare dependence optimal for whom – part 4: In-work tax credits and labour supply

In-work tax credits were introduced in many countries including New Zealand to encourage movement into employment by breadwinners. By linking a large payment with full-time and semi-full-time work, the rewards for working are increased for single parents and families. These in work tax credits combined child tax credit with an in work tax credit for the sole mother or couple.

These in-work benefits can phase-in when a minimum income level is reach such as with the Earned Income Tax Credit (EITC) in the USA, or a paid in full when a minimum number of hours are worked. The Working for Families in-work tax credit in New Zealand and the UK family tax credit are two examples where there is a large cash payment with no phasing-in:

  • Working for Families in New Zealand is paid if 30 hours are worked by New Zealand families or 20 hours are worked by sole parents; and
  • The British family tax credit was paid if 16 hours are worked, initially 24 hours per week.

Figure 1 shows the impact of the introduction of an in-work tax credit paid in full to families and sole parents if a minimum number of hours per week are worked by a family or sole parent. There is no phase-in region such as with the earned income tax credit (EITC) in the USA.

Figure 1: In work tax credits and labour supply

in-work tax credits and labour supply

The in-work tax credit phases-out after once the family’s income increases past an income threshold. This income threshold is usually linked to the number of children as well.

An in-work family tax credit linked to a high number of minimum number of hours worked provides an incentive for those not in work to increase their hours worked by a large amount and leave welfare, as is shown by arrow 1 in Figure 1.

For those already work, the income and substitution effect cut against each other and their net effect depend on the number of hours currently worked.

  • Those working a low number of hours, hours less per week than the minimum to qualify for the in-work tax-credit have an incentive to increase their hours to the minimum to qualify and leave welfare is shown by arrow 2 in Figure 1.
  • Arrows 3 and 4 in Figure 1 both represent reduction in hours worked.
  • Some workers can take-home more pay and work fewer hours per week or per year as shown by arrow 3.
  • Other high working hours worker can enjoy more leisure time at the expense of a slightly reduced take-home pay as shown by arrow 4.

The net labour supply effects of an in-work tax credit are therefore ambiguous because of these multiplicity of labour supply effects with some people working more another’s work in letters.

There will also be a bunching of hours worked at around the eligibility point for paying the in-work tax credit. The eligibility point is usually grouped around working a minimum of three or four days per week part or full-time that sum to 30 hours for families and 20 hours for sole parents.

Workers working less that the weekly working hour minimums will increase to the minimum to qualify for the family tax credit. Workers working more than the minimum required to qualify for the family tax credit might cut back to the working hours minimum because of the superior labour leisure trade-off. The number of people on welfare will fall because workers leave part and full benefit dependence to qualify for the in-work tax credit.

Whether labour supply on net actually increases or decreases depends on the relative numbers of individuals at different points on the budget constraint working full-time, not working and working part-time and on the magnitudes of their responses. Some will stay as they are working full-time, not working and working part-time.

To summarise, the static labour–leisure trade-off model of labour supply suggests that increases in either benefit abatement thresholds or a reduction in benefit abatement rates will increase the numbers entering the benefit and see none leave. No one will leave.

A hours worked per week based in-work tax credit will move people who are not working and working a low number of hours to work and into a higher number of work hours respectively, with bunching around the eligibility point. An in-work tax credit will also cause some to cut back their hours so the net labour supply effect is ambiguous.

The net fiscal cost of an in-work tax credit depends on the phase-in and phased out particulars of the tax credit programme and the increase in paid employment and the number of taxpaying workers as a result of the in-work tax credit. The Working for Families tax credits in New Zealand and the United Kingdom are famous for clustering of labour supply around the eligibility point for the in work tax credit.

single mum graphic

For example, in the UK, a lot of people used to work exactly 24 hours week. When the eligibility point was reduced to 16 per week, a new word had to be invented. This new word was mini-jobs to describe the large number of part-time workers in the UK who cut-back to exactly 16 hours per week. The family tax credit for workers is twice as generous in the UK as in New Zealand.

The blogs so far

part-one-the-labour-leisure-trade-off-and-the-rewards-for-working

part-two-the-labour-supply-effects-of-welfare-benefit-abatement-rate-changes

part-3-abatement-free-income-thresholds-and-labour-supply

part-4-in-work-tax-credits-and-labour-supply

part-5-higher-abatement-rates-and-labour-supply

part-6-mandatory-work-requirements-and-labour-supply

part-7-the-role-of-tagging-in-welfare-benefits-system

Is welfare dependence optimal for whom – part 3: abatement free income thresholds and labour supply

Another welfare reform is a modest income threshold below which benefits are not abated. This is low for unemployment and sickness beneficiaries and higher for domestic purposes and invalid beneficiaries.

The idea behind abatement-free income thresholds is to not penalise part-time work among sole mothers and encourage the unemployed and sick to return to full-time work.

The Figure 1 shows that an increase in the benefit abatement threshold has similar ambiguous net labour supply effects to a lowering of welfare benefit abatement rates.

Figure 1: Impact of abatement thresholds on labour supply

abatement free income threshold

  • Arrow 1 in figure 1 shows that some who were not currently working will now find working part-time a more attractive option because of the introduction of a benefit abatement-free threshold. Their take-home pay is higher although they enjoy less leisure time.
  • Arrow 2 in figure 1 shows that some part-time workers will reduce their working hours because working less and claiming the benefit clearly increases both their take-home pay and allow for more leisure time.
  • Arrow 3 in figure 1 shows that workers who work a relative high number of hours per week for a relative low wage will reduce from full-time to part-time working hours because of a revised leisure-labour trade off now makes a somewhat lower take-home pay worthwhile because of increased leisure time.
  • No welfare recipients leave the welfare system but some join it because of the introduction or increase in the abatement-free income threshold.

The net labour supply effects of a higher benefit abatement-free threshold are ambiguous because the reduced hours of those already in work offsets the labour force participation of those previously not in work.

Whether net labour supply increases or decreases depends on the relative numbers of individuals at different points on the budget constraint working full-time, not working and working part-time and on the magnitudes of their responses. Some will stay as they were either working full-time, not working or working part-time.

The objective of reducing welfare dependency by encouraging part-time work by those not working has important unintended adverse consequences for the labour supply and welfare dependency of those currently working part-time and full-time on low wages.

A common result of welfare reforms that increase abatement thresholds or reduce abatement rates is that no welfare recipients leave the welfare system but some join it. Welfare dependency is not reduced by financial incentives that increase the generosity and the availability of welfare benefits.

The labour supply effects of welfare reforms that increase benefit abatement thresholds or reduce benefit abatement rates are ambiguous because the reduced working hours of existing workers offsets the hours worked by those not employed prior to the reform. A further complexity is that encouraging part-time work channels beneficiaries into low paid jobs that offer little training and other human capital benefits.

In summary, an increase in the benefit abatement-free income thresholds for welfare recipients has the following effects:

  • not all welfare recipients will respond to a higher abatement-free income threshold by supplying more labour;
  • those welfare recipients who do respond to a higher abatement-free income are better-off and supply more labour and take-home more pay;
  • the increase in labour supply is in part-time work by beneficiaries earning income up to the higher abatement-free income threshold;
  • No welfare recipient leaves the welfare system – those welfare recipients who respond to this welfare reform continue to collect their full welfare benefit and work a few more hours each week.

While reforming the welfare system is intended to change the labour market behaviour of welfare recipients, it also has unintended consequences on individuals who are not collecting welfare benefits.

An increase in the exemption level for earned income affects the labour market behaviour of someone who is not receiving welfare benefits has the following effects:

  • prior to the increase in the abatement-free threshold, the individual is best off by working part-time or full-time and not collecting welfare or even being eligible to collect welfare benefits; and
  • after an increase in the benefit abatement-free income threshold, a worker is better-off by supplying less labour and collecting a full welfare benefit, which raises their total income.

Permitting welfare recipients to keep larger amounts of income without losing any of their welfare benefits will attract more workers into the welfare system. Some workers will find that they are better-off by joining the welfare system and switch from full-time work to being a welfare recipient who works part-time (up to the new higher exemption level). The cost of the welfare programme increases, there are more welfare recipients, and no welfare recipient loses any benefits.

All welfare recipients who increase their labour supply up to the new higher exemption level (and lower abatement rates) and all workers who switch to the welfare system will be better-off.

The effect of the quantity of labour supplied is ambiguous: some old welfare recipients will increase their labour supply up to the new higher abatement-free threshold (probably by a relatively small amount) but new welfare recipients will decrease their labour supply (probably by a relatively large amount) as they move from full-time work to part-time work on welfare.

The overall effect of changes in benefit abatement regimes depends on the number of old and new welfare recipients and the size of the labour supply change for each.

  • The quality of labour supplied will deteriorate as some full-time workers switch to welfare and work part-time; part-time workers generally have less attachment to the labour force and tend to invest less in human capital to up-grade their labour market skills.
  • High-productivity workers are working fewer hours while lower-productivity workers work more hours.

If the objective is to reduce the number of people on welfare by moving some welfare recipients (those who are able to work) into work, increasing abatement free income thresholds or lowering abatement rates are not the solution. Both options increase the number of people on welfare.

A reduction in the amount of welfare benefits will reduce the number of people on welfare, reduce the cost of the welfare programme, increase the supply of labour, increase the number of full-time workers relative to part-time workers but make all current welfare recipients worse-off and risks providing inadequate income support to those who are unemployable.

The blogs so far

part-one-the-labour-leisure-trade-off-and-the-rewards-for-working

part-two-the-labour-supply-effects-of-welfare-benefit-abatement-rate-changes

part-3-abatement-free-income-thresholds-and-labour-supply

part-4-in-work-tax-credits-and-labour-supply

part-5-higher-abatement-rates-and-labour-supply

part-6-mandatory-work-requirements-and-labour-supply

part-7-the-role-of-tagging-in-welfare-benefits-system

Is welfare dependence optimal for whom – part 2: the labour supply effects of welfare benefit abatement rate changes

Figure 1 shows that the introduction of a welfare benefit has both income and substitution effects. The welfare benefit abates at rate t so the take-home pay of workers is less than the full wage until the benefit cut out point shown by the arrow in Figure 1. After this cut-out point, no benefits are payable and the work receives a full wage of w times the hours worked.

Figure 1: the labour supply effects of the introduction of a welfare benefit

clip_image002

The income effect increases the consumption of all goods including leisure. The substitution effect increases the attractiveness of not-working relative to work because prior to the cut-out point, take-home pay is less.

· Some workers will choose to not work at all as indicated by arrow 1 in figure 1 because this makes them better off. They have more leisure time and more income.

· Other workers working at a relative low wage will work less hours than before as indicated by arrow 2 in Figure 1 because of the revised rewards of working. Working fewer hours for slightly less is a better labour-leisure trade-off for them. They earn less, but have more leisure time.

Figure 1 illustrates several of the ambiguities of welfare reform. A welfare benefit induces some workers to work fewer hours and others to stop working altogether. In addition, the abatement rate of less than 100 per cent increases the region in which workers working full-time or semi-full-time might find working less hours attractive. Some workers move from full-time work to part-time work on lower income but with more leisure time.

If the benefit abatement rate was 100 per cent, there is a larger gap between working full-time and not working at all. This large take-home pay gap makes jumps from not working to full-time work much more rewarding.

Several jurisdictions increased benefit abatement rates to 100 per cent to make full-time work more rewarding and part-time work less rewarding. Higher benefit abatement rates on earned income of welfare beneficiaries may actually increase net labour supply because fewer workers enter the benefit, more leave for full-time jobs, but fewer work part-time.

These intended and unintended consequences of welfare reform for abatement rate reforms are illustrated further in Figure 2.

Figure 2: Benefit abatement rate reductions and labour supply

clip_image004

Benefit abatement rates are reduced in Figure 2, which increases the cut-out point at which workers cease to be eligible for any welfare benefits.

· Arrow 1 shows the decision of those currently not working to start working part-time, which is a common motive for and the desired outcome behind reduced benefit abatement rates. These beneficiaries are working but are taking-home a higher income. Their labour leisure trade-off now favours more work and less leisure.

· Arrow 2 shows those currently working part-time reducing their hours because this clearly increases both their take-home pay and their leisure time.

· Arrow 3 shows the full-time workers working at a relative low wage have an incentive to reduce to part-time because this is a better labour-leisure trade-off for them. Their take-home pay is less, but they enjoy more leisure time.

The net labour supply effects of lower abatement rates are ambiguous because the reduced hours of those who are already in work offsets the labour force participation of those previously not working.

A key point to remember from this reduction in welfare abatement rates is no welfare recipients leaves the welfare system but some join the welfare rolls because of the reduction in the benefit abatement rate.

Whether labour supply on net actually increases or decreases depends on the relative numbers of individuals at different points on the budget constraint working full-time, not working and working part-time and on the magnitudes of their responses.

Some will stay as they are working full-time, not working and working part-time. Others will reduce their hours of work. The dictates of team production and co-ordinated working times may prevent this happening immediately. At the next job changes, those currently working full and part-time can take full advantage of lower benefits abatement rates as shown in Figure 2.

The objective of reducing welfare dependency and poverty by encouraging part-time work with lower benefit abatement rates has unintended consequences.

People focus on those who start working part-time as a conduit to eventual full-time work and self-sufficiency if welfare abatement rates are lowered to make part-time work more attractive.

What is forgotten is those who are currently working full-time, or part-time, who because of the increase in income from part-time work plus continued for partial benefit receipt find that part-time welfare dependency is optimal for them. They drop out of full-time work.

An additional reason for this entry of new people onto the welfare rolls is that welfare benefits come with a range of second tier benefits. In addition to housing supplements to pay the rent, there are special grants that can be applied for to pay for unexpected expenses such as medical and dental work or damaged around the house.

As alluded to previously, one of the welfare reforms introduced in the United States in the early 1980s was to increase the welfare abatement rate on earned income to 100% from 67% which it applied since the 1960s. This increase in welfare benefit abatement rates to 100% on earned income increased the gap between welfare dependency and working full time. The idea was to make full-time work a more attractive option relative to welfare benefit receipt.

The blogs so far

part-one-the-labour-leisure-trade-off-and-the-rewards-for-working

part-two-the-labour-supply-effects-of-welfare-benefit-abatement-rate-changes

part-3-abatement-free-income-thresholds-and-labour-supply

part-4-in-work-tax-credits-and-labour-supply

part-5-higher-abatement-rates-and-labour-supply

part-6-mandatory-work-requirements-and-labour-supply

part-7-the-role-of-tagging-in-welfare-benefits-system

Is welfare dependence optimal for whom – part 1? The labour-leisure trade-off and the rewards for working

The higher is the welfare benefit, the greater the probability that an individual will choose to go on welfare rather than work. Welfare dependency is the most rewarding leisure-labour trade-off for them.

The higher the wage on offer to a given worker in the labour market, the greater is the probability that they will choose to work rather than go on welfare. Working is the most rewarding leisure-labour trade-off for them.

Both the income and substitution effects of welfare benefits provide a disincentive to work. Higher income levels from generous welfare benefits induce higher consumption of all normal goods, including leisure. Income taxes and a high benefit abatement rate provides little incentive to work (the substitution effect) for lower paid workers and some second earners.

When confronted with the choice of a low-paying job and a generous welfare benefit, some will choose welfare over work. These workers are responding rationally to the (dis)incentives embedded in the labour market and welfare system. For them, welfare dependency is optimal.

This is particularly true for single parents with low labour market skills. One or more children may generate more net income (from increased welfare benefits) than working in the labour market and paying child care. If there is no expiry date for these welfare benefits, some individuals who go on welfare will stay on welfare for a long period of time.

Of course, the economics of crime comes up. A condition of receipt of welfare benefits in just about every welfare state is healthy adults must make themselves available for work and actively look for work.

Most of the essentials of the impact of welfare reform on labour-leisure trade-offs are captured, and most policy dilemmas are clearly defined within the framework in Figure 1. Figure 1 illustrates the position of two workers regarding whether to work (the participation decision) and how many hours to work.

Figure 1: The basic leisure-labour trade-off

The hourly wage rate represented by the symbol W in Figure 1 is traded-off against working fewer or no hours. This additional of leisure time includes: pure leisure; household production such as child care, cooking and cleaning; education and other human capital investments; and personal time such as self-care and sleep.

  • Worker 1 in Figure 1 works 40 hours while worker 2 with different circumstances works part-time in Figure 1.
  • Worker 1 could be a male with no dependents so not working full-time has a relatively high opportunity cost even if low paid.
  • Women who higher qualifications are also more likely to be persistent workers alternating between full-time career and part-time work when there are child care responsibilities.
  • Worker 2 in Figure 1 could be a sole parent or a second earner in a married couple with young children. For these workers, working can have a high opportunity cost because of the cost of child care, especially if the sole parent or second earner is low paid.
  • For workers with a high opportunity cost of work and low wages from working, for them, welfare dependents can be quite optimal.
  • Not so for society because the welfare benefits conditional on people making themselves available for work and taking steps to find it and stay in work.

The next few blogs will explain how various welfare reforms change the labour leisure trade-off for welfare recipients. There are three main parameters in any welfare system:

  1. the amount of the welfare benefit,
  2. the threshold for the benefit abatement on earned income, and
  3. the benefit reduction rate for income exceeding the abetement-free threshold.

This is not to ignore work testing and work requirements, these complications are postponed to later blogs. All of these parameters and the implications of changing them on labour supply will be discussed in future blogs.

The blogs so far

is-welfare-dependants-optimal-for-whom-part-one-the-labour-leisure-trade-off-and-the-rewards-for-working

is-welfare-dependence-optimal-for-whom-part-two-the-labour-supply-effects-of-welfare-benefit-abatement-rate-changes

is-welfare-dependency-optimal-for-whom-part-3-abatement-free-income-thresholds-and-labour-supply

is-welfare-dependents-optimal-for-the-whom-part-4-in-work-tax-credits-and-labour-supply

is-welfare-dependence-optimal-for-whom-part-5-higher-abatement-rates-and-labour-supply

is-welfare-dependence-optimal-for-whom-part-6-mandatory-work-requirements-and-labour-supply

is-welfare-dependence-optimal-for-whom-part-7-the-role-of-tagging-in-welfare-benefits-system