In-Work Benefits for Married Couples: An Ex-Ante Evaluation of EITC and WTC Policies in Italy

Giuseppe De Luca,Claudio Rossetti,Daniela Vuri

doi:10.2139/ssrn.2119046

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 two in-work benefit schemes following the key principles of 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 in-work benefits is however augmented with a new benefit premium for two-earner households in order to overcome the well-known disincentive effects that these welfare instruments may generate on secondary earners. In simulation, the proposed in-work benefits are financed through the abolition of Italian family allowances for dependent employees and contingent workers thus ensuring tax revenue neutrality. We show that our EITC and WTC reforms have strong positive effects on labor supply of wives, weak negative effects on labor supply of husbands, and strong positive effects on equity. The EITC is more effective than the WTC in boosting employment of wives, while the WTC is more effective than the EITC in fighting poverty. In both schemes, the trade-off between labor supply incentives and redistributive effects is crucially related to the new benefit premium for two-earner households. Other things being equal, tax revenue neutrality implies that a higher value of this policy coefficient yields stronger incentive effects and weaker redistributive effects.

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

Introduction

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

Methods

Results

Conclusion