IZA Tower Talk - Report

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Negative Income Tax vs. Workfare
Debate on Promoting the Low Wage Sector
The quest to find the silver bullet to fight persistently high unemployment among the low-skilled in Germany was the focus of the 18th IZA Tower Talk, which took place at the Post Tower in Bonn on 8 August 2007. Peter Bofinger, member of the German Council of Economic Experts, presented his model of supplementing low incomes with a kind of negative income tax, while IZA Director of Labor Policy Hilmar Schneider, presented the IZA’s workfare concept. In a discussion chaired by Bonn General-Anzeiger Editor-in-Chief Joachim Westhoff, Bofinger and Schneider discussed the political necessities in light of these quite different yet, from Bofinger’s point of view, reconcilable models. Bofinger and Schneider both, however, doubted the readiness of policymakers to implement the adjustments to the structures of the welfare state and its incentive mechanisms that have been suggested by the Council of Economic Experts.

In his presentation, Peter Bofinger cited the all too high burden of social insurance contributions on the low wage sector among full-time employees (Germany’s is the second highest in all of the OECD) as the central cause of unemployment. In order to alleviate this situation, his model proposes a subsidy equal to the amount of the social insurance contributions, which would be paid to recipients of low wages who work 30 hours or less in a full working week. This would present a significant incentive for job-seekers to accept full-time employment. Above all, this concept would de-stigmatize the target group, enabling them to return to the labor market “with dignity” instead of being permanently labeled “needy”.
Hilmar Schneider contrasted this model with IZA’s workfare approach, which would result in much higher employment effects, while cutting the welfare state costs to a much greater extent. By introducing an obligatory reciprocal service in the form of non-profit full-time work for employable recipients of unemployment benefits (ALG II), the disincentives inherent in the current social security system could be removed. Due to these wrong incentives, very few low-qualified workers have found it worthwhile to even consider seeking a job, since the likelihood of achieving a wage considerably higher than the amount received through transfer payments was pretty low. However rational this mindset may be, it has resulted in a decreasing supply of such jobs, which could hardly be filled anyway. On the other hand, there has also been a remarkably high level of activity in the shadow economy. Although Schneider conceded that combined wages made simple tasks more attractive, he pointed out that the Bofinger Model, like every in-work benefit concept, was likely to generate significant windfall gains, since individuals earning higher hourly wages might reduce their working hours in order to enjoy the subsidies and more spare time, while their income would remain constant. In contrast, workfare would offer massive incentives for transfer recipients to take up gainful employment, as they could achieve a higher income – while working the same number of hours – if they accepted a job that was only slightly better paying than the transfer receipt.

The main “argument” of both economists was to which extent the implementation of workfare meant accepting displacement effects associated with supplying non-profit work. While Peter Bofinger held this to be the central weakness of the workfare approach, Hilmar Schneider pointed out that the changed labor supply alone would generate more demand by firms and, furthermore, that professional service agencies could keep displacement effects to a minimum. At the same time, the workfare principle of reciprocal service would end the massive displacement of regular employment by the informal economy. Both experts agreed on the critical appraisal of “mini jobs”. In particular, Peter Bofinger advocated their immediate abolition in order to foster regular employment.