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Abstract
This paper investigates labor supply and redistributive effects of in-work benefits for Italian married couples using a tax-benefit microsimulation model and a multi-sectoral discrete choice model of labor supply. We consider in-work benefits based on the Earned Income Tax Credit (EITC) and the Working Tax Credit (WTC) existing in the US and the UK, respectively. The standard design of these income support mechanisms is however augmented with a premium for two-earner households to avoid potential disincentive effects on secondary earners. Revenue neutral policy simulations show that our reforms may greatly improve the current Italian tax-benefit system in terms of both incentive and redistributive effects. Furthermore, neglecting sector-specific attributes of the various job opportunities may lead to an oversimplified representation of the choice set that does not allow to capture some labor market transitions and thus results in attenuated labor supply responses.
Highlights
In-work benefits are usually promoted as income support mechanisms that encourage employment in the low-skilled population while maintaining high levels of social protection
The Earned Income Tax Credit (EITC) is more effective than the Working Tax Credit (WTC) in boosting employment of wives, while the WTC is more effective than the EITC in fighting poverty
EconLav is applied to a subsample of married couples from the 2008 wave of the Survey on Household Income and Wealth (SHIW) to approximate the budget sets of each sample unit under both the baseline tax-benefit schedule in the year of data collection and the hypothetical schedules resulting from our in-work benefit reforms
Summary
In-work benefits are usually promoted as income support mechanisms that encourage employment in the low-skilled population while maintaining high levels of social protection. Economic theory and previous empirical evidence suggest that family-based schemes, where the benefit is means-tested against household income, generally promote employment among primary household earners (Bargain and Orsini 2006; Blundell 2000; Blundell and Hoynes 2004; Eissa and Hoynes 2004; Eissa and Liebman 1996) Such schemes are likely to create, negative labor supply effects on secondary earners as their earnings may move households in regions of the budget set with high marginal tax rates (Eissa and Hoynes 2004). To contrast these unintended disincentive effects, some countries have experienced individual-based schemes where the benefit is means-tested against individual income (Immervoll and Pearson 2009). Whether labor supply incentives and redistributive effects can be reconciled into a single welfare instrument is still an open issue
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