The employment effects of lowwage subsidies. Kristiina Huttunen Jukka Pirttilä Roope Uusitalo - PDF

254 The employment effects of lowwage subsidies Kristiina Huttunen Jukka Pirttilä Roope Uusitalo PALKANSAAJIEN TUTKIMUSLAITOS TYÖPAPEREITA LABOUR INSTITUTE FOR ECONOMIC RESEARCH DISCUSSION PAPERS 254 The

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254 The employment effects of lowwage subsidies Kristiina Huttunen Jukka Pirttilä Roope Uusitalo PALKANSAAJIEN TUTKIMUSLAITOS TYÖPAPEREITA LABOUR INSTITUTE FOR ECONOMIC RESEARCH DISCUSSION PAPERS 254 The employment effects of lowwage subsidies Kristiina Huttunen* Jukka Pirttilä** Roope Uusitalo*** We are grateful to Matz Dahlberg, Tomi Kyyrä and seminar participants at the Athens University of Economics and Business, the Helsinki Centre for Economic Research, the CESifo Area Conference on Labour Economics, the University of Jyväskylä, and the 2009 EALE Conference (Amsterdam), the Nordic Summer Institute in Labour Economics (Aarhus), and the Nordic Seminar for Public Economics (Uppsala, Sweden) for useful comments. Kari Eerola provided excellent research assistance and Ossi Korkeamäki helped with calculations involving the FLEED data. Financial support from the Finnish Employees Foundation is gratefully acknowledged. *Labour Institute for Economic Research **Corresponding Author, Address: Department of Economics, University of Tampere, Finland. ***Government Institute for Economic Research, IZA and IFAU Helsinki 2009 ISBN ISSN ABSTRACT Low-wage subsidies are often proposed as a solution to the unemployment problem among the low skilled. Yet the empirical evidence on the effects of low-wage subsidies is surprisingly scarce. This paper examines the employment effects of a Finnish payroll tax subsidy scheme, which is targeted at the employers of older, full-time, low-wage workers. The system s clear eligibility criteria open up an opportunity for a reliable estimation of the causal impacts of the subsidy, using the difference-in-difference-in-differences approach. Our results indicate that the subsidy system had no effects on the employment rate. However, it appears to have increased the probability of part-time workers obtaining full-time employment. Key words: low-wage subsidies, employment, social security contributions. JEL Classification: H24, J23, J68. TIIVISTELMÄ Matalapalkkatuen työllisyysvaikutukset Usein esitetty ratkaisu vähän koulutetun työvoiman työttömyysongelmaan ovat matalapalkkatuet, mutta niitä arvioivaa empiiristä tutkimusta ei ole paljon. Tässä työssä tutkitaan suomalaisen työnantajille suunnatun matalapalkkatuen työllisyysvaikutuksia. Tuen selkeä kohdentuminen (siihen ovat olleet oikeutettuja täysaikaisia, yli 54-vuotiaita matalapalkkaisia palkanneet) tarjoaa hyvän mahdollisuuden arvioida tukijärjestelmän vaikutuksia luotettavalla tilastotieteellisellä tavalla. Tulostemme mukaan tukijärjestelmä ei kasvattanut kohderyhmän kokonaistyöllisyyttä. Sen sijaan osa osa-aikaisista työntekijöistä siirtyi täysaikaisiksi tukijärjestelmän ansiosta. Asiasanat: matalapalkkatuki, työllisyys, sosiaaliturvamaksut 3 1. INTRODUCTION One way to reduce unemployment among the low skilled is to cut labour taxation for lowincome workers. This raises the question about the general effectiveness of targeted tax cuts and also the more nuanced question about what the best way is to implement these cuts. Phelps (1994, 1997) and Dreze and Malinvaud (1994), for instance, argue that a subsidy given to the employers of low-skilled workers could be more effective in increasing the demand for those workers than a reduction in the taxes paid by the employees. The reason is that if wages are rigid downwards, the subsidy reduces labour costs and therefore increases labour demand more than a reduction in the labour income tax paid by the employees themselves. 1 Low-wage subsidies, in the form of targeted cuts to employers social security contributions, have also been implemented in practice, for example in Belgium and in France. In some other countries, notably Germany, there is a debate on whether low-wage subsidies should be introduced. 2 Kramarz and Philippon (2001) and Crepon and Desplatz (2002) provide econometric evaluations of the French system. 3 While these papers represent high-quality empirical work on the subject, some elements of the French system render its evaluation a complicated task. In particular, minimum wages have been changed simultaneously with the subsidy system. The French system also provides benefits to all low-wage workers, which makes it hard to find a proper comparison group that could be used to predict what would have happened to low-wage employment without the subsidy scheme. Low-wage subsidies have also attracted a large amount of theoretical analysis, based on searchtheoretic frameworks (see e.g. Chéron, Hairault and Langon (2008) and Brown, Merkl and Snower (2007) and the references there). This strand of literature often involves simulation analyses with empirically plausible parameter values or structural econometric work. Another sizable literature deals with hiring subsidies (see Katz 1996 for a survey and Bell, Blundell and van Reenen (1999) or Kangasharju (2007) for more recent evidence). The evidence on the effects of these temporary subsidies is, however, not necessarily suitable for assessing the effectiveness of permanent low-wage subsidies. 1 Edlin and Phelps (2009) argue, in addition, that low-wage subsidies might be an especially effective way to increase demand in a recession. 2 See, for instance, Knabe and Schöb (2008), which builds on the theoretical analysis in Knabe et al. (2006). 3 A large amount of other relevant empirical work exists. This literature is reviewed in more detail in Section 2. 4 On balance, it seems fair to say that empirical evidence on the effectiveness of low-wage subsidies is still scarce. This is in marked contrast to the evidence of the targeted tax cuts for employees. This evidence builds on the experience from in-work benefit systems implemented in the US and the UK. The Working Families Tax Credit (WFTC) in the UK and the Earned Income Tax Credit in the US appear to have, indeed, been successful in increasing employment among the target groups. The design of these systems, involving a clear division between the target group and non-eligible persons, has opened up an opportunity for reliable econometric work that has been able to isolate the causal impacts of these policies (see Eissa and Liebman (1996) and Eissa and Hoynes (2004) for the US case and Blundell 2006 for the UK evidence). Even more compelling is experimental evidence from the Self-Sufficiency Project, which provides earnings subsidies for welfare leavers in Canada. (See e.g. Michalopoulos et al. (2002) and Card and Hyslop (2005).) In addition, because of large differences in labour market institutions, it is not entirely clear that a scheme that works in the Anglo-Saxon countries is directly applicable to countries, say, in Continental Europe or in the Nordic states. The difference in the nominal recipient of the subsidy (the employee in the case of the EITC and the WFTC, the employer in the original Dreze-Malinvaud and Phelps proposals) can also imply that the success of low-wage subsidy schemes cannot be evaluated based on the evidence on in-work benefits. The purpose of this paper is to offer new evidence on the causal effects of low-wage subsidies by examining the impacts of a highly targeted low-wage subsidy experiment that started in Finland in Finland is a good case for analysing the effectiveness of payroll tax subsidies. Union contracts have led to a relatively narrow wage distribution which could have contributed to the gap in the unemployment rates between low-skilled and high-skilled workers that is among the largest in Europe, according to the Eurostat Labour Force Survey. The design of the Finnish low-wage subsidy scheme makes evaluating its impacts relatively straightforward. In order to be eligible for the subsidy, workers must be over 54 years of age, earn a salary between 900 and 2,000 euros per month and work full time. This means that we can find several comparison groups for the targeted workers, thus allowing the difference-indifference-in-differences (DDD) approach. We can simultaneously control for any permanent differences across the eligible and ineligible groups and take into account time-varying differences in labour demand for different skill groups. The latter, particularly, may be quite important if skill-biased technical change or globalisation changes the relative productivity of 5 different workers. In this paper we use this setup to study the impacts of the low-wage subsidy scheme on wage rates, hours worked and employment (mainly via retention rates), offering a full analysis of the incidence and the employment effects of the system. The paper proceeds as follows. Section 2 reviews earlier relevant empirical work. 4 Section 3 explains the Finnish subsidy system in more detail. The actual empirical analysis in the paper has many phases and utilises several different data sets. Therefore it may be useful to set out a fairly detailed plan of the empirical content of this paper. In section 4, we look at the trends in the employment rates of workers in different age groups using data from the Finnish Labour Force Survey. The main purpose is to examine the overall employment impacts of the subsidy system. In section 5, we use register-data of the unemployed and examine in detail whether the subsidy system affected re-employment rates. The main interest is in finding out whether there was a change in re-employment rate of older unemployed workers, and in particular in reemployment rate of those older unemployed with low pre-unemployment income level or low education level. This section therefore investigates whether the subsidy system led to increased entry to the workforce of those unemployed who were likely to benefit from the subsidy system. Section 6, representing the bulk of our analysis, builds on a detailed data set that covers all workers of employers that are members of the Finnish Employers Confederation. The benefit of these data is that they contain detailed information about the working hours and monthly wages of the workers that are needed to strictly target the analysis to the affected workers. This enables us to build a clearly defined treatment group and corresponding control groups (in other words, the DDD analysis). This data is then used to examine the exit rates of workers employed by these firms. In addition, we estimate the impacts of the subsidy system on the working hours and wages of those workers who keep their jobs. Finally, section 7 discusses results from a number of extensions to the analysis above. Section 8 concludes. 4 For the sake of space, we do not cover the theoretical literature on payroll tax subsidies here. Brown et al. (2007) contains an extensive list of theoretical work in the area. 6 2. EARLIER EMPIRICAL WORK The best-known scheme of targeted social security cuts has been implemented in France, where payroll taxes were first reduced in March 1994 by 5.4% for workers earning no more than 1.1 times the minimum wage and 2.7 per cent for workers in the range between 1.1 and 1.2 times the minimum wage. The subsidy was increased dramatically in September 1995 and its range was extended in October At the end of 1996, the subsidy was 18% at the minimum wage and decreased linearly thereafter, hitting zero at 1.33 times the minimum wage. 5 The employment effects of the French payroll tax subsidy scheme have been evaluated by Kramarz and Philippon (2001) and Crepon and Desplatz (2002). Given that the French subsidy is universal, both studies suffer from a lack of a natural comparison group. Kramarz and Philippon base their evaluation on household survey data and examine the effects of changes in the minimum labour costs - hence capturing the effects of both the minimum wage changes and the changes in payroll tax subsidies at the minimum wage level. By comparing workers affected by the minimum wage increases with workers just above the new minimum wage, they show that increases in labour costs increase transitions to non-employment. However, their analysis regarding the effects of a decrease in the labour costs due to an increase in the payroll tax subsidy reveals no significant employment effects. The authors measure this as an increase in minimum-wage workers coming from non-employment. Crepon and Desplatz (2002) perform their analysis using firm-level employment as the key dependent variable. They calculate the ex-ante change in labour costs due to the payroll tax subsidies, using payroll tax parameters and the composition of the firm s labour force before the introduction of the payroll tax changes. They find that employment in firms that received larger subsidies grew more than employment in firms that employed fewer low-wage workers and hence received fewer subsidies. The authors interpret this as strong evidence for the employment effects of low-wage subsidies. Since the outcome variable is total employment, the authors cannot discover whether the increase in employment occurs in the targeted lowwage group or whether the increase in employment is due to an increase in high-wage workers. 5 The Finnish and French subsidy systems are roughly similar in magnitude, but the Finnish subsidy is phased out more slowly and hence has an impact on labour costs at much higher wage levels. Another important difference is naturally that the French subsidy affects all low-wage workers, while the Finnish subsidy is targeted at older workers. 7 Targeted payroll tax subsidies have also existed in the Netherlands and in Belgium. We are not aware of the econometric evaluations of the Dutch system, but Bovenberg et al. (2000) evaluate its effects using a simulation model calibrated to Dutch data. Their conclusion is that the most effective way of reducing unemployment is the introduction of in-work benefits, though the simulation results between the benefits paid to the low-wage workers or to the employers of these workers are roughly similar. Goos and Konings (2007) evaluate the effects of changes occurring in the Maribel subsidies system in Belgium in the late 1990s using firm-level data. These subsidies reduced the payroll taxes paid on manual workers. Even though the subsidy was not specifically targeted to the employers of low-wage workers, its lump-sum structure reduced the payroll taxes for the low-wage workers more than for the other groups. Goos and Konings find that the subsidy had significant effects on employment. The subsidies discussed above involve a decrease in the payroll taxes of the subsidized workers. Gruber (1994) analyses the effect of a reverse experiment, increasing the costs of hiring certain groups by increasing mandatory employer contributions. He examines the effects of forcing employers to purchase health insurance that includes maternity benefits, a change mainly affecting young women. He shows that the costs of these group-specific mandates are mainly borne by workers in terms of lower wages and that the additional costs have little effects on employment. While permanent non-categorical subsidies to all employers of the low-wage workers are rather rare, there is a large literature evaluating the effects of temporary subsidies to employers who hire long-term unemployed persons or workers with disabilities. Many of these programs have been evaluated using randomised trials. In his comprehensive survey of the US programs Katz (1996) concludes that wage subsidies have been effective in improving the earnings and employment of disadvantaged groups, at least when combined with training elements. More recent evidence is available from Britain, where the so-called New Deal system has led to modest improvements in the productivity of the target group (Bell et al. 1999), and Finland where temporary subsidies for the unemployed who find work have been found to be effective (Kangasharju 2007) 6 Finally, related literature looks at the impacts of regional employment subsidies (see e.g. Korkeamäki and Uusitalo (2009) and Bennmarker et al. (2009). 6 See also Gesine (2009) that focuses on the wage effects of hiring subsidies. His paper also includes an extensive survey of the empirical work on hiring subsidies. Since temporary hiring subsidies are often one part 8 As discussed in the introduction, an alternative to employer-based subsidies is to target the subsidy to employees. This is the way in which the Earned Income Tax Credit in the US and the Working Families Tax Credit in the UK are designed. Despite the different nominal recipients, there are also similarities that make the results from the evaluation of these subsidy schemes relevant for the Finnish case. All these schemes share the property that the subsidy is targeted to the low-wage workers and that the subsidy gradually decreases after earnings increase above some threshold level. All these schemes are also intended to be permanent subsidies for the low-wage workers instead of temporary subsidies for the newly hired. Importantly for the evaluation, all these schemes also have other eligibility criteria in addition to low earnings. This allows us to compare wage and employment changes after the introduction or expansion of the subsidy in the eligible group and in some comparison group that is in a reasonably similar position in the labour market. Using this strategy, Eissa and Liebman (1996) and Blundell (2006) compare the changes in labour supply between single mothers and (ineligible) single women without children. Both of these studies find substantial effects on the labour supply. 3. THE FINNISH EMPLOYER LOW-WAGE SUBSIDY SCHEME Since January 1 st 2006 Finnish employers have been eligible for a wage subsidy if they employ a low-wage worker that is over 54 years old. The subsidy-scheme is temporary and will be in force until December The subsidy depends on the wage level and may be up to 16 per cent of the gross wage or 13 per cent of the total pre-reform labour costs including payroll taxes. The subsidy covers full-time workers who are employed at least 140 hours per month and whose wage is between 900 and 2,000 euros per month. The subsidy equals 44 per cent of the part of the monthly wages that exceeds 900 euros. The maximum subsidy per employee is 220 euros a month. The amount of the subsidy is reduced by 55 per cent of the monthly wages exceeding 1,600 euros. of active labour market policies, our paper is also related to the literature of evaluating these policies. For one survey, see Calmfors et al (2004). Recent evidence is available e.g. in Adda et al (2007) and Sianesi (2008). 9 The wage subsidy is paid to the employer and can be seen as simply a reduction in the payroll tax rate for the firms that employ old low-wage workers. In 2006 the average payroll tax rate was 20.9 per cent of the gross wage. The tax is levied on all wages. The revenues are mainly used for funding the employee s pension system and the sickness insurance. The tax rate is slightly higher for larger and more capital-intensive firms. For large firms, pension payments also vary according to the age structure of the employees and according to the disability and unemployment pensions granted to former employees. Still, even for large firms the payroll tax is a proportional tax on all wages paid. The 2006 tax subsidy created a system where the payroll tax rate is a decreasing function of monthly wages when wages are between 900 and 1,400 euros. The payroll-tax rate is at its minimum (5.2%) when the monthly wage equals 1,400. When wages are between 1,400 and 1,600 euros, firms get the maximum subsidy of 220 euros. The subsidy is gradually reduced when wages increase above 1,600 euros so that the subsidy reaches zero when the monthly wage equals 2,000 euros. In this phase-out range the payroll taxes are strongly progressive with tax rates increasing from 7.2 % at the wage level of 1,600 /month to roughly 21% at the wage level of 2,000 /month. Figure 1 illustrates the effects of the low-wage subsidy by plotting the reduction in the payroll tax due to the
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