This paper estimates the welfare and distributional impact of two types of welfare reform in 14
member countries of the European Union. The reforms are revenue neutral and financed by an
overall and uniform increase in marginal tax rates on earnings. The first reform distributes the
additional tax revenue uniformly to everybody (traditional welfare) while the second reform
distributes tax proceeds uniformly to workers only (in-work benefit). We build a simple model
of labor supply encompassing responses to taxes and transfers along both the intensive and
extensive margin. We then use EUROMOD to describe current welfare and tax systems in
European Union countries and use calibrated labor supply elasticities along the intensive and
extensive margins to analyze the effects of the two welfare reforms. We quantify the equitye
ciency trade-off for a range of elasticity parameters. In most countries, because of the large
existing welfare programs with high phase-out rates, the uniform redistribution policy is, in
general, undesirable unless the redistributive tastes of the government are extreme. The inwork
benefit reform, on the other hand, is desirable in a very wide set of cases. We discuss
the practical policy implications for European welfare policy. |
