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Welfare and Work Incentives: A North European Perspective.

The issue of the labor market impact of welfare programs and the taxes necessary to finance them is growing in importance in the United States and much of the developed world. In Europe there is a paucity of evidence as to the existence and magnitude of these effects. In 1987 the Danish Rockwool Foundation commissioned a study of the state of knowledge in the field for Denmark and three neighboring nations; Germany, Sweden and the United Kingdom. This book is the summary of these studies. The reader will find the background information on the tax and transfer systems of interest as well as their effects.

Bjorn Gustafsson and N. Anders Klevmarken examine the effects of taxes and transfers in Sweden. In 1983, Sweden had marginal income tax rates for high income earners in excess of 80 percent (the current figure is about 50%.) Currently, some families find the reduction in ghild benefits from increased income, coupled with taxes result in marginal effective tax rates in excess of 100%. Further, the income tax of couples is calculated separately for each spouse. This separate taxation of income, coupled with family leave policies and generous child-related transfers, helps to explain the relatively small difference in the labor supply of the two sexes and an overall adult labor force participation rate in excess of 80 percent. Swedish wives contribute about one-third of family after-tax income, a figure three times that of Germany. In examining the effects of the transfer system, the authors conclude that; (1) higher rates of the sickness insurance compensation increase absentee rates, (2) increased potential pension payments reduce the labor supply of older workers and (3) generous child-care policies increase the rate of absence from the labor force by young mothers.

The maximum marginal income tax rate in the United Kingdom fell from 83% to 40% in the 1980s, while the basic rate fell from 33% to 25%. Richard Blundell used these changes to simulate the effects of changes in tax rates on labor supply. He concludes that increasing income tax rates might reduce the labor supply of wives a bit (a backward-bending supply curve) but that the reduced take-home pay of their husbands would result in increased hours by wives (an income effect.) The overall response for full-time workers appears to be small. A. B. Atkinson examines the effects of benefits and work incentives in Britain. He found that in some cases working families will face marginal tax rates of 96% when one accounts for reduced family and housing benefits and lower local tax credits. Although there have been some modifications in recent years, in 1992-93 750,000 working families faced composite tax rates (taxes paid and benefits reduced) in excess of 70%. Despite these extremely high marginal tax rates facing some families, Atkinson concludes that the reduction in labor supply caused by these programs in negligible, with the response of women somewhat greater than men.

Klaus F. Zimmerman presents data demonstrating that compared to other Western European nations, Germany has a somewhat lower labor force participation rate, an older work force and a lower birth rate. The labor force participation rate of women with children under the age of six was only 41.1% (a figure close to 60% in the United States.) Although almost-universal, low-cost, subsidized child care is available, it does not serve to increase female labor force participation much since there is little care for children under the age of three and 90% of the child care centers do not take children for more than half of a day. After a detailed review of the evidence, Zimmerman concludes that the labor supply of males is not very responsive to taxes and transfers. The labor supply of females is somewhat more sensitive, but not overly so. The German system of splitting joint income for tax purposes, rather than taxing it separately, tends to reduce the labor supply of women, also.

The changes in Denmark have been quite remarkable over the last few decades. Peder J. Pederson points out that since 1950 the size of the public sector has increased substantially, the overall labor force participation has risen and unemployment also increased. Taxes rose to an amount in excess of one half of GNP by the mid-1980s before falling. Currently, high-income taxpayers still face actual marginal tax rates of 68%. Pederson finds that these tax rates do reduce labor supply, but only slightly. Further, high marginal tax rates, coupled with value-added taxes, result in more do-it-yourself work and greater participation in the shadow economy. Relatively high unemployment benefits, that can in some cases extend up to eight years, boost unemployment, but not by much.

There is a concluding chapter, but the length (nine pages) and depth is somewhat disappointing. Although the authors do occasionally comment on the results from other nations in the text, the cross-national comparisons are limited both in the text and the concluding chapter. Further, given the mission of the book to present the labor supply effects of taxes and transfers, a general policy prescription for Denmark and perhaps other nations might have been of interest. The basic conclusion of these studies is that labor supply effects are in general small. The labor supply of women, particularly married women and single mothers, is more responsive to changes in taxes and transfers. There is, however, no consensus about the magnitude of these estimates. Despite this lack of in-depth cross country comparisons and policy prescription, the volume is extremely useful for presenting detailed descriptions of the tax and transfer systems of these North European nations along with their labor market impacts.

Robert J. Gitter Ohio Wesleyan University
COPYRIGHT 1995 Southern Economic Association
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Author:Gitter, Robert J.
Publication:Southern Economic Journal
Article Type:Book Review
Date:Apr 1, 1995
Words:940
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