Carrots from the Premiers

I have a little piece in today’s Sydney Morning Herald on welfare reform, arguing that reform will be more successful if it uses carrots and sticks. Because the feds seem reluctant to offer more than punitive policies, the states and territories should consider paying work subsidies. Full text – with a few hyperlinks – over the fold.

By the way, I owe the word “carrotly” to two other bloggers: Red Rag and Melbourne Philosopher. And thanks to Mike for pointing us to the actual interview transcript (NB. An earlier draft of this post incorrectly said that KCB used "carrotly" in a JJJ interview. It was actually a 2CC interview.)

A pat on the back is better than a kick in the behind
Sydney Morning Herald, 11 July 2005

The states have the money to lure people back to work, writes Andrew Leigh.

With the Federal Government gearing up to reform its welfare system, the jobs debate seems to be splitting into two simplistic camps. Some argue that welfare dependency is a problem that can be solved only with punitive policies, while others reject the view that welfare dependency is anything to worry about. This false dichotomy is leading Australian welfare policies astray.

Welfare dependency is a problem. In the late 1960s, 87 per cent of working-age men had full-time jobs. Today, only 66 per cent do, with many now reliant on income support. Not only has women’s employment not risen enough to make up for the fall in participation by men, but employed women are increasingly choosing employed men as their partners. At a family level, this means that rich households are working more, but poor households are working a lot less. One in six children live in a household without an adult in the labour force. Mark Twain once said: "If work were so pleasant, the rich would keep it for themselves." Now they have.

The Federal Government has opted to deal with welfare dependency mainly through punitive policies. Under the new regime, people with school-aged children who receive parenting payments must search for at least part-time work. Unemployed workers aged 50-64 face more stringent requirements on their search for work. And qualifying for disability benefits has become harder.

By contrast, welfare reforms implemented in the US during the 1990s used a combination of penalties and incentives to increase workforce participation. While strict time limits were applied to welfare benefits, those entering the labour force also received a large wage subsidy, in the form of a tax credit. For poor families with two children, the subsidy can be worth more than $US4000 ($5400) a year.

An important question from the US reforms of the 1990s is which had more effect on moving people off welfare – penalties or incentives? Separate studies by Jeffrey Grogger, and by Bruce Meyer and Dan Rosenbaum, give more kudos to the big carrot (the earned income tax credit) than to the various sticks (such as time limits on receiving welfare). This provides a clear policy lesson for other countries seeking to move more people into work: if you want to be successful, wage subsidies should be part of the solution.

The US is not the only country to have this kind of wage subsidy program. Britain’s earned income tax credit program provides a wage subsidy of up to £3000 ($7000) to induce parents into the workforce. Many other developed countries, including Belgium, Finland, France and the Netherlands, also have income tax credits to boost workforce participation.

Yet Australia has largely eschewed wage subsidies. While the so-called "five economists" proposal in 1998 received broad support among academics, the Howard Government took little notice. For its part, the Labor Party proposed an income tax subsidy in the 1998 and 2001 election, but dropped the idea for the 2004 election. Current wage subsidy programs tend to be targeted at particular groups (such as apprentices, older workers, the disabled and indigenous people), or operate for only a very short time. Australia provides generous benefits to families with children, but because they are not linked to workforce participation and have high income thresholds, they end up operating more like middle-class welfare than as incentives to help low-income parents into the labour force.

Can the Federal Government be persuaded to amend its welfare reform proposals to take what the Opposition Leader, Kim Beazley, recently called a more "carrotly" approach? At this stage, the odds are not good.

But there is an alternative. As the Treasurer, Peter Costello, has pointed out, land taxes and higher-than-expected GST revenue have left state Labor governments flush with cash. Rather than heeding Costello’s call to cut business stamp duties, state and territory governments should hold true to their Labor values by putting in place wage subsidies for the low-income earners. In conjunction with the Government’s more punitive welfare reforms, this could lead to a worthy rise in the employment rate, for which the states would rightly deserve most of the credit.

The Howard-Costello welfare reforms are poor policies – in both senses of the phrase. It’s time for the state and territory leaders to help them work.

Dr Andrew Leigh is an economist at the Australian National University.

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14 Responses to Carrots from the Premiers

  1. Andrew Norton says:

    Andrew – I’m not sure why the government’s proposals should be regarded as ‘punitive’. After all, being required to do something in exchange for money is hardly unusual, even in the welfare system (students must study, single parents must retain custody of their kids).

  2. Andrew N, you need to look at the detail of what people are often required to do in exchange for money. Too often it’s meaningless make work or totally generic “training” not worthy of the name – and endless bureaucratic appointments with Centrelink and Job Network Providers.

  3. Andrew Leigh says:

    Andrew, I take your point. I did search the thesaurus for a softer synonym of “punitive”, and couldn’t find one. Perhaps I should’ve used Kim Beazley’s word: “stick-y”.

  4. Robert says:

    Andrew, Beazley’s “carrotly” comment was quoted in a recent issue of the Big Issue.

  5. Andrew Norton says:

    Mark – But the point of these things is not to punish people, it is to keep them moving in looking for a job. They may be effective or ineffective, but they are not punishment.

  6. Mike says:

    Big Kim used the word In an Interview on 2cc here is the transcript
    sorry i have no idea how to do a good link I hope this works.


  7. Andrew Leigh says:

    Thanks Mike – yo da man. Have amended the post accordingly. Now, I wonder why a search for carrotly on the ALP website brings up no hits?

  8. J Asker says:

    I strikes me that if the objective is to increase the transition probability from unemployment to employment then there are more direct icentives that would not mess up the slope of the marginal tax rate schedule and possibly do weird things to EMTRs for large amounts of the population (although making EMTRs any weirder would require some work…).
    For instance, given that both states are easily observable from tax and welfare records, why not just pay a lump sum to people who make the transition and stay in employment for 6 months or a year or similar. Further, to reduce the incentives for manipulation of payments via cycling in and out of employment, make the payment payable only once every 2-3 years and make it payable via a credit for income tax – so it is only useful for those who stay working.
    This would seem far more directed and less expensive.

  9. Andrew Leigh says:

    John, I’m less worried about EMTRs in the phase-out range than most people. Behaviour adjusts most in response to taxes that people understand well. So pensioners are very responsive to their EMTR, since it doesn’t change much, and they have a lot of time to study the code. But EITC recipients face a more complex tax system that depends on kids, work hours, and partner income. So I argued in my job market paper that many of them may indeed be responding to their average tax rate, which would predict no negative effects in the phase-out range (and indeed most studies find small effects in the phaseout range).

    I like your proposal, though. Australia has something called the “Working Credit” (the temporary EITC that I alluded to in my oped), whose value is proportional to the time spent unemployed. I don’t think this is a dumb idea, but the amounts are so small that I don’t think it will have had much of an effect on labour supply. Oh, and I’d like to do a real evaluation on it, using admin data stored in a computer down the hall, but the govt ain’t so keen….

  10. J Asker says:

    So, setting redistributive issues aside, it seems to me that if you want a first order effect on transition from unemployment to employment you ideally want to give a first order incentive. Its never been clear to me that the EITC does this in the most effective way.

    I agree that the transparency of the incentives is a first order issue. And couldn’t agree more about simplifying the tax system so that the incentives are transparent.

    Sorting out EMTRs would help – probably not with unemployment but I suspect underemployment and under untilisation of labour. In particular, a review of the benefits that are income and means tested would seem sensible.

    Startling (but unpublished) data I saw recently on the French system revealed that the range of EMTRs for those around the 30th percentile of the income distribution was from 20-110%. This suggested that the differential impact of means tested welfare was highly varied and (I’m guessing) unintentional.

  11. Andrew Leigh says:

    John, it’s actually not clear to me that we want all incentives to be transparent. In the case of the EITC, I think the US government is right to make people very clear about the incentives on the phasein range, and muddy the waters about the phaseout range.

    And yes, I suspect the French tax system’s incentives are at least as messy as Australia’s. They’ve just implemented an EITC, but it’s only a few hundred bucks per year.

  12. Andrew N, on further reflection, what’s problematic about the activities Newstart recipients are required to participate in is:

    (a) Many are not designed or capable of actually giving people marketable skills and transitioning them into work – for instance Work for the Dole – which has not been properly evaluated and even the evaluations the Government has released demonstrates it makes little difference in terms of outcomes;

    (b) Attention is not given, as far as I can see, to sociological and psychological research on the increase in depression, loss of skills (both vocational and social) which go along with unemployment in the design of programmes.

    In short, policy is not driven by evidence as to what works in terms of sticks but ideology. Another example is a recent study of the Dole Diary which found that it increased the intensity of people’s search but not their propensity to find work.

  13. J Asker says:

    Cobber Leigh,

    You have to be transparent about the entire incentive system. As a first order issue, I’d think households should reasonably expect government to be upfront about the structure of the benefits they recieve. If not you invite the outcome that people just believe they’ll be screwed no matter what and the power of all incentives is diminished (and, just as importantly, breach any sense of trust between government and the people).

    If you can muddy the waters in a way that maintains trust between the government and welfare recipients, then you may be right (albeit on dubious ground ethically). However, I’m pretty skeptical about this.

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