Description
You will write one 1,500-2,000 word critique of one of the theoretical models developed in class. Your critique should be constructed as an essay, with an introductory paragraph that previews your key arguments, followed by 3-5 main body paragraphs that develop your arguments in more detail, and ending with a final paragraph and summarizes your key points and concludes.
A good critique will address at least a few of the following questions:
1) What are the essential assumptions in the model? Are these assumptions realistic? Are they falsifiable?
2) What are the model’s key predictions? Are these realistic?
3) How would you go about testing the predictions of the model? Why might this be difficult,
in practice?
4) Can you imagine a different model that might generate similar predictions through a
different mechanism?
5) What do we learn from the model that we didn’t already know?
You don’t need to appeal to outside sources; however, if you do, be sure to cite them appropriately. Your arguments should be self contained, well thought out, precise, and well supported.
Labour Supply and Public Policy
Laura Salisbury
ECON 3249: Labour Economics
Summer 2019
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 1 / 43
Labour Supply and Income Support Programs
Important public policy goal: poverty reduction.
Support individuals when they cannot work due to illness,
unemployment.
Support individuals who cannot earn enough to support themselves and
their families.
BUT income support programs can create disincentives for work.
Raise reservation wages
Create “tax” on earnings at low levels
Balance policy objective of poverty reduction and social insurance
with negaitve labour supply effects.
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 2 / 43
Income Support Programs
Analyze labour supply effects of different income support programs in
Canada
Demogrant
Welfare
Negative Income Tax
Wage Subsidy/Earned Income Tax Credit
Employment Insurance
Disability Insurance and Workers Compensation
Child Care Subsidy
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 3 / 43
Demogrant
Demogrant:
Lump sum transfer to specific demographic group
i.e. Single parents, persons over 60, families…
Example: Old Age Security (OAS)
Monthly payments to people over 65
What does this do?
Shift budget line outward
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 4 / 43
Demogrant
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 5 / 43
Demogrant
Overall effects?
Demogrant = pure income effect
Increase both consumption & leisure, decrease hours worked.
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 6 / 43
Welfare
Eligible for welfare if income falls below defined threshold.
Threshold varies by province and other characteristics, including family
type.
Health and Social Transfer Program (federal)
Traditional welfare scheme:
Guaranteed level of income: benefits equal to YB when person works
zero hours.
Benefits reduced 1 for 1 with earnings.
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 7 / 43
Welfare
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 8 / 43
Welfare
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?
Reduce benefits
Increase wages
Change preferences
Reduce implicit tax rate
Costs and benefits associated with each.
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 9 / 43
Welfare
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 10 / 43
Welfare
Example:
U = c
1/3L
2/3
⇒ MRS = 2 ∗ c/L
T = 24
YN = 0; YB = 4
w = 1
How much will individual work if there is no welfare system?
How much will individual work if there is a traditional welfare system?
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 11 / 43
Negative Income Tax
Negative income tax programs:
Like welfare, a guaranteed minimum income.
BUT earned income does not reduce benefits 1 for 1.
Benefits reduced by t for every dollar earned.
Net income: Y = YB + (1 − t)E
YB is guaranteed minimum
E is income earned from working
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 12 / 43
Negative Income Tax
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 13 / 43
Negative Income Tax
Example:
U = c
1/3L
2/3
⇒ MRS = 2 ∗ c/L
T = 24
YN = 0; YB = 4
w = 1
t = 0.5
Same as above, but with negative income tax.
How much will individual work under this welfare regime?
Compare with earlier results.
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 14 / 43
Negative Income Tax
Negative income tax still reduces employment relative to no welfare.
But it reduces employment less than traditional welfare scheme.
Potential downsides:
More expensive for government than traditional welfare?
Larger payouts?
Must weigh cost to taxpayers against positive effects of increased
labour supply.
These benefits can be social as well as economic.
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 15 / 43
Wage Subsidies
Wage subsidies:
A transfer of s for every dollar earned.
Net income: Y = (1 + s)wH
H is time spent working, w is wage rate.
Intended to encourage people to work more
But effect may be ambiguous:
Subsitution effect: encourages people to work more
Income effect: encourages people to work less
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 16 / 43
Wage Subsidies
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 17 / 43
EITC
Earned Income Tax Credit (EITC)
US program designed to reduce number of people on welfare
Wage subsidy at low levels of income
“Phase-out” period with negative income tax
Thresholds: L1, L2
When T > L > L1, net wage is (1 + s)w
When L1 > L > L2, net wage is (1 − t)w
When L2 > L > 0, net wage is w
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 18 / 43
EITC
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 19 / 43
EITC
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 20 / 43
Employment Insurance
Employment Insurance (EI):
Largest income security program for working-age people
Eligibility: worked a minimum number of hours (12 to 20 weeks at 35
hours per week); lost job involuntarily and without fault.
Replaces 55 percent of lost earnings subject to maximum
Two effects:
Discourages people receiving EI to work, since benefits will be lost.
Encourages people to work minimum number of hours required for EI
eligibility.
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 21 / 43
Disability Payments and Worker’s Compensation
Disability payments:
Workers’ compensation
Disability pension entitlements (CPP, QPP)
Long term disability insurance (employer & employee premiums)
Why do we care about work incentive effects?
If worker is completely unable to work, incentives do not matter
Incentive effects matter for workers with some discretion over time
spent working.
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 22 / 43
Effect of Disability
How does disability affect worker’s budget constraint?
Restrict amount of time a person can spend working.
May be restricted to no time.
How does disability affect worker’s utility?
Forces worker onto lower indifference curve by forcing hours worked
below optimum
Disability itself can increase disutility from hours spent working
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 23 / 43
Effect of Disability
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 24 / 43
Effect of Disability
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 25 / 43
Workers Compensation
Workers’ Compensation
Restore income lost due to disability
Ex. 2/3 of lost income
Depending on worker’s preferences, this may create incentive not to
return to work.
In case of permanent disability (unable to ever return to work),
unclear what happens to utility with workers’ comp.
Receive extra utility from inreased amount of leisure
BUT incur additional costs: medical bills, pain and suffering
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 26 / 43
Workers Compensation
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 27 / 43
Workers Compensation
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 28 / 43
Workers Compensation
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 29 / 43
Child Care Subsidy
Child Care Subsidy
Benefit to working parents
Child care is a fixed cost
Creates inward shift in budget constraint when person is working a
positive number of hours
Effect:
Increases reservation wage: need a certain amount of income to
rationalize incurring cost of child care
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 30 / 43
Child Care Subsidy
Child care subsidy takes away this fixed cost.
What is the effect on labour supply decisions?
People who DO NOT work in absence of subsidy:
Subsidy will lower reservation wage, which may induce them to enter
labour force.
People who DO work in absence of subsidy:
Subsidy amounts to demogrant
Pure income effect: cause people to reduce labour supply
Again, policy choices must balance costs and benefits.
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 31 / 43
Evidence of Incentive Effects
How do we test what the labour supply effects of income support
programs are?
For instance, suppose we want to know whether welfare causes labour
supply to decrease. How would we prove this?
Sufficient to show that welfare recipients work less?
No!
Benefits recipients and non-recipients do not have same characteristics
Cannot be sure which differences are caused by benefits, and which are
caused by different characteristics.
Sufficient to show that LFP lower when welfare benefits higher?
Not necessarily
Depends on what else was happening.
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 32 / 43
Evidence of Incentive Effects
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 33 / 43
Evidence of Incentive Effects
Ideal: experimental evidence.
Generate truly random variation in benefits, see how people respond.
Example: Self Sufficiency Project
Offer earnings supplement to some welfare recipients, none to others
Treatment group randomly selected
Findings: earnings supplement encouraged 15% of recipients to leave
welfare for full time work.
Large scale experiments not always possible.
What do economists do when they don’t have experimental evidence?
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 34 / 43
Case Study: EITC in United States
Eissa and Liebnam (1996)
EITC program expanded by Tax Reform Act of 1986 (TRA86)
Measure labour supply effects on labour supply decisions of single
mothers
Why is this a difficult thing to measure?
In general, difficult to pin down causal effect of income support
program on labour supply.
Not valid to simply compare labour supply of people receiving benefits
with people receiving no benefits.
Benefits recipients and non-recipients do not have same characteristics
Cannot be sure which differences are caused by benefits, and which are
caused by different characteristics.
Change in benefits program = “Natural Experiment”
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 35 / 43
Case Study: EITC in United States
Characteristics of EITC program:
Three criteria:
Has earned income (wage % salary plus self employment income)
Income below specified threshold ($28,495 for taxpayer with 2+
children in 1996)
Must have qualifying child
Amount of credit (1996 rules):
Phased in at 40% rate over first $8890 of income
Earn additional 40 cents for every dollar earned up to this point
Maximum benefit is $3556
Benefit remains constant as income rises to $11,610
Benefit phased out at 21.06% rate as income rises above $11,610
Keep only 78.94 cents for every dollar earned
Fully phased out when earned income equals $28,495
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 36 / 43
Case Study: EITC in United States
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 37 / 43
Case Study: EITC in United States
Predicted effects:
For women currently not participating in the labour force, EITC will
increase wages, potentially above their reservation wages.
Should increase labour force participation
What about hours worked?
Depends on number working in absence of policy:
Working more than D: no effect
Worker btw D & C: negative income and subsitution effects: should ↓
hours
Worker btw B & C: pure income effect: should ↓ hours
Worker btw A & B: negative income effect, positive subsitution effect:
ambiguous overall effect.
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 38 / 43
Case Study: EITC in United States
Question 1: did expansion of EITC benefits increase labour force
participation of single mothers?
Approach to answering this question:
Compare change in labour supply of single mothers, before and after
benefits expansion, to change in labour supply of control group (single
women with no children).
Differences in differences
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 39 / 43
Differences in Differences
Why don’t they just look at the change in LFP among single mothers
before and after policy change?
First difference: ∆LFPTREAT = LFPTREAT
2 − LFPTREAT
1
What if LFP changes for some reason not related to policy change?
Time trend, other policy changes, etc.
Need control group who would have experienced the same time trend,
other policy changes, etc but not the policy change of interest
(EITC).
Use single women with no children.
Diff in Diff estimator:
DD = ∆LFPTREAT − ∆LFPCONTROL
Laura Salisbury (ECON 3249) Labour Supply and Public Policy Summer 2019 40 / 43
Case Study: EITC in United States
Laura Salisbury (ECON 3249) Labor Supply and Public Policy Summer 2019 41 / 43
Case Study: EITC in United States
Findings:
EITC expansion increased labor force participation
Even controlling for different characteristics of single mothers vs single
women
No effect on hours worked.
Effect on the extensive margin rather than intensive margin.
Laura Salisbury (ECON 3249) Labor Supply and Public Policy Summer 2019 42 / 43
Case Study: EITC in United States
What do you think of this research design?
Are single women without children a good control group?
Why did they find an effect on participation but not hours worked?
Knowledge of program?
Measurement?
Laura Salisbury (ECON 3249) Labor Supply and Public Policy Summer 2019 43 / 43
Sample Solution