Conditional Earnings Subsidies for Low Earners

• DOI: http://doi.org/10.1111/sjoe.12358
• Date: 01 April 2020
• Published date: 01 April 2020

Scand. J. of Economics 122(2), 524–552, 2020

DOI: 10.1111/sjoe.12358

Conditional Earnings Subsidies for Low

Earners*

Erwin Ooghe

KU Leuven, Leuven B-3000, Belgium

erwin.ooghe@kuleuven.be

Abstract

In order to be eligiblefor in-work tax credits, it is often not enough to have low earnings. In Ireland,

New Zealand, and the United Kingdom, for example, for eligibility, it is also required that the

number of hours worked is sufficiently high. Similarly, in Belgium and France, the hourly wage

rate must be sufficiently low. In this paper, I providea justification for such additional conditions.

I analyze Pareto-efficient redistribution from high to low ability individuals in a model where

labor has several intensivemargins. Besides labor hours, labor effort – a vector of unpleasant, but

productive features of labor – is also an object of choice. Effort and ability determine the hourly

wage rate. I find that conditional subsidies on earnings for low earners are optimal: the earnings

of low earners should be subsidized at the margin, but only if they earn more by working more

hours at a sufficiently low wagerate.

Keywords: In-work tax credits; optimal taxation

JEL classification:H2; I3; J2

I. Motivation

Welfare policies try to find – within budgetary limits – a good balance

between two, often conflicting, goals: maintaining sufficiently high living

standards and encouraging work. Over the past decades, the latter has

became a more prominent goal in many countries – witness the introduction

or reinforcement of in-work tax credits (OECD, 2011). Such tax credits

reduce the effective marginal tax rates and hence increase the incentives

for low earners to work.

In order to be eligible for in-work tax credits, it is necessary, but

often not sufficient, to have low earnings. For eligibility, it might also be

necessary either for the number of hours worked to be sufficiently high or

*Thispaper has benefited from discussions with Rolf Aaberge, Spencer Bastani, S¨orenBlomquist,

Robin Boadway,Bart Cap´eau,Vidar Christiansen, Andr ´e Decoster, St´ephane Gauthier, Laurence

Jacquet, Tobias König,Ar naud Lefranc, Sebastiaan Maes, Holger L¨uthen, François Maniquet,

David Margolis, Ronald Peeters, Andreas Peichl, Paolo Piacquadio, Erik Schokkaert, Kevin

Spiritus, Alain Trannoy, TomTruyts, Frank Vandenbroucke,Toon Vanheukelom, JavierVázquez-

Grenno, and three anonymous referees.

C

The editors of The Scandinavian Journal of Economics 2019.

E. Ooghe 525

for the hourly wage rate to be sufficiently low. I provide two examples of

real-world policies.

To obtain a Working Tax Credit in the United Kingdom, it is necessary to

have an annual income below £13,100 (as a single individual aged between

25 and 59 and without children), but it is also necessary to work at least

30 hours a week.1The base payment is currently up to £1,960 per year.

Other tax credits with minimal conditions on the number of hours worked

are the Working Family Payment in Ireland2and the In-Work Tax Credit in

New Zealand.3

To be eligible for a Werkbonus (work bonus) in Belgium, monthly gross

earnings must be below 2,510 euros, but the gross wage rate must also be

lower than 156 percent of the minimum wage.4The bonus is currently up to

2,562 euros per year (if an individual works one year full-time as a laborer

at the minimum wage). Another tax credit with a maximum condition on

the wage rate was the Prime Pour l’Emploi in France, which was replaced

by the Prime d’Activit´ein 2016.5

One plausible justification for such additional conditions is to deter

or even exclude mimickers (i.e., relatively able individuals who could

become eligible by working fewer hours). Although deterring mimicking

is a well-known mechanism in the optimal tax literature, to the best of my

knowledge, it has not been used to justify conditional subsidies on earnings

for low earners.

In the classical Mirrleesian model, there simply is no room for subsidies

(Mirrlees, 1971). In this model, unidimensional agents choose labor along

the intensive margin and only earnings can be taxed by an inequality-averse

welfarist planner. These four assumptions together imply that the optimal

marginal earnings tax rate is non-negative everywhere.

At least three assumptions turn out to be crucial. Indeed, negative

marginal earnings tax rates can be optimal if agents are heterogeneous

along multiple dimensions (Boadway et al., 2002; Fleurbaey and Maniquet,

2006; Chon´e and Laroque, 2010), if labor is chosen along the extensive

margin (Diamond, 1980; Saez, 2002; Chon´e and Laroque, 2011), or if the

planner is either not inequality averse (Stiglitz, 1982; Werning, 2007) or not

1See https://www.gov.uk/working- tax-credit for details about the Working Tax Credit in the

United Kingdom.

2See http://www.citizensinformation.ie/en/social welfare/social welfare payments/

social welfa re payments to families and children/family income supplement.html.

3See http://www.ird.govt.nz/wff-tax-credits/understanding/all- about/iwtc/in-work-tax- credit.

html.

4See https://www.socialsecurity.be/employer/instructions/dmfa/nl/latest/instructions/

deductions/workers reductions/workbonus.html (in Dutch, French,or Ger man).

5See https://en.wikipedia.org/wiki/Prime pour l’emploi.

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The editors of The Scandinavian Journal of Economics 2019.