Abstract
In this paper I simulate the entrance to the labor market in the presence of cultural barriers that constraint labor market participation of low-income workers. In this case, an optimal EITC depends on social planner’s relative preferences for persistently unemployed and working poor. I check EITC optimality in the short run under different types of social planners - from mild inequality averse to Rawlsian; and different kinds of policy makers – conservative, who favors the Working Poor, and liberal, who tolerates cultural barriers and favors the unemployed. Using simulations, I find that the imposition of an EITC is optimal in all cases, except for a Rawlsian and liberal policy-maker under the unusual case of full compliance to minimum wage. By calibrating the model for Israel, a country with well-documented cultural barriers for labor market participation, I find that the proposed framework will remain relevant in the foreseeable future. In light of these results and of EITC documented advantages, its scare use in developed economies remains an open question that merits further research.
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Notes
Immervoll, H., H. Kleven, C. T. Kreiner and E. Saez (2004) performed simulations with linear utility of consumption in which labor costs play a significant role.
As I show in the literature survey, cultural barriers are clearly relevant for immigrants. However, in the present context it is so mainly for the second generation born in the foreign country. The topic of desired policy concerning first immigrants’ generation is a crucial policy issue, which is beyond the scope of the present paper.
This assumption is made only for achieving an analytical solution which technically eases the analysis and allows obtaining results without the need for running simulations. The parameters used under this function assure that the solution keeps relevance compared to reality. In section 5 I use an equal CRRA utility function for tax-payers, minimum-wage worker and persistently unemployed; by using simulations I show that the basic results concerning optimal EITC are relevant also in this case.
Such an analysis is presented by Regev and Strawczynski (2019).
Malul and Luski (2009) show that when education is part of individual’s decisions the EITC is not necessarily an optimal tool for young individuals.
In fact, in a dynamic model we would hardly accept that re-distribution occurs in a set-up where individuals do not participate for ever as a consequence of cultural factors. In such a model, we would expect that cultural factors evolve over time – raising the question of optimality in a framework where cultural factors tend to vanish; such a case is analyzed by Regev and Strawczynski (2019).
For a high δ, which represents cultural barriers, the derivative of labor supply with respect to the EITC may be positive or negative depending on the values of the wage and risk aversion. However, since for this case we assume a high δ, the individual with cultural barriers does not participate, and consequently does not receive an EITC.
In the logarithmic case (θ = 1) the income effect of the EITC as shown in the first term of the denominator of 8′ does not exist, because it cancels out with the same term in the numerator. Note that when there are cultural barriers (i.e., δ is high) the EITC will not affect the entrance decision since the term in the numerator of 8′ will be negative. Thus, the omission of the income effect that is related to the EITC subsidy in the logarithmic case is of a minor importance in this analysis.
Income maintenance systems are usually contingent on chronic unemployment. Concerning participation, an appropriate tool would be selective (i.e., mean-tested) child allowances.
As in many re-distributive models I restrict myself to income taxation revenues that are used for transfers to low income individuals. This approach follows Saez (2002), who assumed that intervention is aimed at redistribution.
Note that the situation differs to the usual non-linear optimal income tax problem as presented by Mirrlees (1971): in that context the heterogeneity of wages drives increasing utility with wages (see Stiglitz 1987). In the present context, if we assume the opposite assumption (i.e., that IM is higher than minimum-wage worker’s full-time wage) and if labor causes disutility, then there is a clear incentive not to work; in that case we would have a corner solution where all minimum-wage workers population becomes chronically unemployed, which is not compatible with what we see in reality. Thus, our assumption assures agent monotonicity in terms of utility, fulfilling the incentive compatibility constraint.
This assumption means that basically individuals at persistently unemployed/minimum-wage groups are willing to work; i.e., they are not “lazy” as eventually mentioned in public discussions.
See Gruber and Saez (2002).
Since these groups do not participate we cannot calculate their income maintenance stipend; moreover, for these two groups the child allowances and spouse stipend constitute the relevant alternative for participating at the labor market.
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Acknowledgements
Thanks to Yoshihiro Takamatsu for a helpful discussion and to participants at the 75th IIPF Conference in Glasgow for useful remarks.
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APPENDIX
APPENDIX
Let us now calculate the alternative income IM. For that purpose, we need to know the number of children, since child allowances is the main source for an alternative income in the case of non-participation. Table 7 shows the data.
Based on the number of children we calculate the child allowances as a source of alternative income. Single parents receive mainly the maintenance stipend as stipulated by law. In Table 8 I show the alternative income of the different groups.
These tables provide all the elements for calculating the labor aversion parameter, by applying equation (9)’. Table 2 shows the estimates of the δ-threshold for the different groups.
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Strawczynski, M. Optimal EITC in the Presence of Cultural Barriers for Labor Market Participation. J Labor Res 41, 233–259 (2020). https://doi.org/10.1007/s12122-020-09303-6
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DOI: https://doi.org/10.1007/s12122-020-09303-6