Alleviating unemployment traps in Finland: Can the efficiency-equity trade-off be avoided? Pertti Honkanen The Social Insurance Institution of Finland/Research Dept. Markus J

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Alleviating unemployment traps in Finland Can
the efficiency-equity trade-off be avoided?
Pertti HonkanenThe Social Insurance Institution
of Finland/Research Dept. Markus JänttiÅbo
Akademi University Jukka PirttiläLabour
Institute for Economic Research1st General
Conference of the International Microsimulation
Association2022 August 2007, Wien
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Purpose of the study

• To estimate how labour supply incentives have
  changed in Finland 1995 2007
• participation tax rates
• effective marginal tax rates
• To compare incentive effects of various reform
  packages
• poverty reducing package
• across-the-board tax cuts
• incentive package

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Background on Finland

• Severe economic depression in the 1990s
• High unemployment figures in the middle of 1990s
  (maximum 18 20 )
• Persisting long-term unemployment in spite of
  strong economic growth (actual figures
  registered unemployment about 8 of labour
  force)
• Income inequality and poverty rates risingsince
  1995
• Major features in economic policy
• tax cuts for wages and other labour income
• social benefits cuts in the middle of 1990s,
  modest development since the year 2000

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Some features of benefit and tax system in Finland

• Three unemployment compensation systems
• earnings-related unemployment benefit (max. 500
  days) employment record and unemployment fund
  membership necessary
• basic unemployment benefit (max. 500 days)
  flat-rate, employment record necessary
• labour market subsidy generally means-tested,
  employment record not necessary, no upper limit
  of duration (depends on participation in
  activation measures)
• Housing allowance for low-income households
• Means-tested income support
• Child benefits for all families having children
  under 17 years
• Earnings-related tax-credits (only wage and
  labour incomes)

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JUTTA model

• a new comprehensive static tax-benefit model
• covers all relevant legislation for the years
  19902007, partly also for earlier periods
• developed for open use in cooperation with Labour
  Institute for Economics, Åbo Akademi University
  and Social Insurance Institute of Finland
• data Statistics of Finland income data file
• 28 000 29 000 individuals,
• 10 000 11 000 households
• about 700 different variables for each
  individual or household
• technique
• function modules programmed with C-language
• Excel-sheets for fictive examples, tables and
  reports
• Access-databases for data and parameters
• simulation with SQL-queries
• user interface programmed with Visual Basic

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Background for study

• theoretical and empirical studies on labour
  market participation
• participation decisionvs. decision on working
  hours
• extensive vs. intensive margin
• important source Immervoll, H., Kleven, H. J.,
  Kreiner, C. T., Saez, E. (2007). Welfare reform
  in European countries A microsimulation
  analysis. Economic Journal, 117 (516), 144

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Central concept of the study

• Participation tax rate
• where
• ?l net taxes (taxesbenefits) for employed
• ?u net taxes (taxesbenefits) for unemployed
• w hypothetical, predicted wage (calculated by
  regression taking into account occupation, age
  etc.)

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Steps of calculation

• participation tax rate is calculated for
  unemployed in the 2004 data (about 2 500 persons
  in the sample)
• the unemployed are converted first to whole-year
  unemployed and then it the second stage to
  whole-year employed
• participation tax rate is calculated from the
  outcomes of the two simulations
• to the same data legislation of the years 1995,
  2000, 2004 and 2007 is implemented
• monetary parameters adjusted with cost-of-living
  index for the years 1995, 2000 and 2007
• also effective marginal tax rates are calculated
  for all individuals having labour income and for
  corresponding years (1995, 2000, 2004, 2007) (1
  percent increase in income)

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Results

• Participation tax rates have been decliningin
  the years 19952007
• but differences in levels by household type and
  other variables

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For some groups high participation tax rates
possible
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Effective marginal tax rates
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Income inequality policy vs. striuctural changes

• Method comparing simulated inequality measures
  with real figures
• simulation with same data (2004) but with
  variable legislation
• Changes in taxes and transfers account for a
  great part of the increase in income inequality

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Steps of calculation, 2nd stage

• Different reform packages are simulated and
  compared with the results for the base year 2007
• tax package general tax cuts for wage and
  labour incomes
• poverty reducing package improvements of
  benefits and tax cuts for small incomes
• incentive package different measures reducing
  the extent of means-testing and encouraging
  labour-market participation (e.g. reducing
  day-care payments) but no benefit cuts
• The gross budget costs for different packages are
  of the same order (about 600 million euros)

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"Incentive package"

• Dismantling the means-testing (dependence of
  familily income) of unemployment assistance
  (labour market subsidy)
• Day-care fees reduced for employed persons
• Earned income tax credit made dependent of the
  number of children
• Partial unemployment assistance made less
  dependent on wage income
• Means-testing (marginal effect) of housing
  assistance reduced
• Means-testing on income support reduced the free
  amount of earned income increased
• Universal child benefits increased

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Incentives and employment?

• It was not possible to demonstrate, that changes
  in incentives had an effect on employment in the
  period 1995 2004
• Employment improved but possibly for other
  reasons than better incentives
• Experiment with participation elasticies
• reform packages have only a modest effect

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Conclusion

• Different packages have different effects on
  income distribution and on incentives
• It is possible to formulate a policy package
  (incentive package), which reduces inequality and
  poverty and at the same time improves labour
  supply incentives