Topic 3: Labour Supply and Public Policy Flashcards
Analyze labour supply effects of different government programs, collectively known as income support programs: Government Grants Welfare Negative Income Tax Wage Subsidy Earned Income Tax Credit Analyze empirical evidence of public policy effects: Randomized Control Trial Approach: The Self-Sufficiency Project Difference-in-Difference Approach: EITC Expansion
What’s a government grant?
- Lump sum transfer from the government.
- Generally subject to certain eligibility criteria, e.g. single parents, persons over 60, families…
- Examples:
- Old Age Security (OAS): Monthly payments to people over 65
- Conditional Cash Transfers (CCT): common in developing countries; given to parents conditional on sending their kids to school, for example.
- Basic Income: Unconditional transfer to all residents
How does a government grant affect the budget line and preference?
- It shifts budget line outwards.
- Government Grant = pure income effect Increase both consumption & leisure, decrease hours worked
- Increase reservation wage: MRS= G/L
True or False? A government grant increases consumption but less than what the grant dictates because there’s a reduction in working hours?
True. Remember C=w(T-L)+G. we assume YN=0 for all public policies. Therefore, L will reduce G’s impact because reducing L results in reduced working hours which results in reduced C.
What’s the purpose of traditional welfare?
Guarantees minimum level of income. Eligible for welfare if income falls below defined threshold. -Threshold varies by province and other characteristics, including family type.
What is the traditional welfare scheme?
Traditional welfare scheme:
- Guaranteed level of income: benefits equal to G when person works zero hours.
- Benefits reduced 1 for 1 with earnings.
What are the effects of a traditional welfare scheme in terms of reservation wage, encouragement to work and social burden?
Effects of traditional welfare scheme:
Increases reservation wage
Discourages individuals from working for wage at which they might otherwise be willing to work a positive amount of hours.
May have more people on welfare than is socially optimal.
What might reduce the number of people on welfare?
- Reduced welfare benefits
- Increaseing the wage rate
- Changing preferences
- Reduce implicit tax rate
Costs and benefits associated with each.
What`s the difference between negative income tax and traditional welfare
Like welfare, a guaranteed minimum income.
- BUT earned income does not reduce benefits 1 for 1.
- Benefits reduced by t for every dollar earned.
If your income is below a threshold B, you receive a transfer of G − tE from the government, where E is the gross income earned from working: E = w(T − L).
If you have no earnings (E = 0), you receive G from the government but the higher your earnings E, the lower the transfer you receive.
Once your labour earnings reach the threshold B, the subsidy disappears completely.
Assuming YN = 0, the budget constraint is given by:
C = w(T − L) if E > B
C = w(T − L) + G − tw(T − L) = (1 − t)w(T − L) + G if E < B
What are the effects of the negative income tax on Leisure, employment and potential side-effects on labour market
Net wage is lower, so there is a substitution effect pushing for ↑ L. At the same time, total income is higher, so there is an income effect also pushing for ↑ L.
Negative income tax reduces employment relative to no welfare I But it reduces employment less than traditional welfare scheme.
Potential downsides: More expensive for government than traditional welfare? Larger payouts?
What is the formula for the negative income tax budget constraint?
- C= w(T-L) + G-tW(T-L)
The highlighted portion represent labour earnings, the unhighlighted portion represent government transfer.
- C= (1-t)W(T-L) + G
Define wage subsidies
In wage subsidies, governments provide funds proportional to people’s earnings or a transfer of S for every dollar earned.
S = wage subsidy → percentage top-up from government.
Effective earnings rate becomes (1 + S)W
It’s intended to encourage people to work more.
Net income: Y = (1 + S)W(T -L)
What is the formula for net income during a wage subsidy?
Net income: Y = (1 + S)W(T -L)
What are the effects of a wage subsidy in terms of substition and income effects?
Overall effects are ambigious.
Substitution effect: encourages people to work more because of price of leisure increases
Income effect: encourages people to work less. e.g wealthier want to increase leisure
May encourage entry of non-participants.
What is an Earned Income Tax Credit (EITC) ?
The EITC is a US program designed to reduce the number of people on welfare. It is similar to the Working Income Tax Benefit (WITB) in Canada.
What are the 3 key characteristics of the EITC/WITB program?
- “Phase-in”: wage subsidy at low levels of income.
- “Flat Range”: After a certain income threshold, wage subsidy stops, but accrued subsidy does not have to be paid back.
- “Phase-out”: After a further income threshold, there is a “phase-out” period where the additional earnings are taxed to recover the cost of the subsidy.
What is the difference between the EITC/WITB and the traditional welfare scheme?
What are the formulas for DID?
For the first formula the effect come to (change due to treatment + change that would occur w/o treatment) - (change w/o treatment)
For the second formula below the, it comes to (pre-existing difference + impact of policy) - ( pre-existing difference)
** Look at example presented in notes**
