Factors required for successful reforms
The general objective of policies aimed at increasing employment incentives or ‘making work pay’ is to pro- mote increased access to employment and returns from economic activity. As stated above, jobs should be eco- nomically rewarding. This policy incorporates potentially important social and economic externalities in terms of social inclusion, greater self-esteem, increased welfare, and reduced social problems.
Options include general reforms of benefit schemes to increase the difference between in-work and out-of-work income, to increase the net reward from additional work effort, and to target programmes at groups of people who are at the margin of the labour market. The latter may include policies such as in-work benefits, targeted tax credits (negative income taxes), benefit transfers or wage subsidies to employers. Furthermore, reforms for tight- ening eligibility rules and requiring appropriate labour market behaviour from benefit recipients are also impor- tant for mobilising labour supply. The success of such policies differs across segments of the labour market and depends on a number of factors:
• the proper identification of problems and of main
objectives of policies;
• general framework conditions such as the overall gen-
erosity of tax-benefit systems, the wage floor, mini- mum wage legislation and earnings distribution;
• the trade-offs between policies targeted at different
groups since policies may be accompanied by negative side-effects such as dead-weight costs, displacement and substitution effects;
• the interaction between benefit and tax systems with
the functioning and reforms of other labour market institutions.
The most important trade-off between policies targeted at different groups of people concerns the choice of whether to improve the position of those out of work or those in work, that is between the objectives of reducing the unemployment trap or the poverty trap.
Direction of tax and benefit reforms in Member States
Member States are committed in the framework of the Luxembourg process to put a series of programmes in
(1) The indicator of the first column is another way (compared to the
net replacement rate) of looking at incentives in the case where the principal earner moves from unemployment benefit to full-time employment.
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place to help unemployed persons to participate more fully in the labour market. Reform tax and benefit systems to make work pay and a shift from passive income support towards active measures are designed to get people back to work. However, recent reforms show the emphasis has clearly been on tax systems, while the most recent changes in benefit schemes have not been particularly significant (European Commission, 2000b).
The overall tax burden on labour in the EU has started to decline slightly since 1996. The tax reforms implemented represent a move in rendering the tax system more employment-friendly. However, the reform effort has been unequal, varying in coverage and depth across Member States. Moreover, the taxation of labour in many Member States (namely Belgium, Sweden, Germany, Finland, France, Italy, Austria, Denmark and the Netherlands) is above the EU average (41 %) and compares with less than 30 % in the United States and Japan.
Over the last five years, most Member States also suc- ceeded in reducing the tax wedge on low-paid labour, notably thanks to reductions in employers’ social security contributions on low wages. However, in general, the tar- geting of tax cuts at the lower end of the wage scale is not strong, and in most Member States tax reductions on labour have been more general than targeted. Nonetheless, further reductions directed at the lower end of the wage scale are expected according to recently announced tax reforms.
Regarding benefit systems, the starting positions of most Member States are characterised by relatively high net replacement rates for unemployment benefits as well as for social assistance. However, benefit spending to work- ing-age population as a share of GDP has turned on to a downward trend, which seems to suggest a tightening or stricter control of eligibility rules, although the reform effort still seem to be insufficient.
Member States have started to reform benefit and pension schemes in order to encourage older people to stay longer in working life. The measures taken to this end include the tightening of eligibility rules and making early retirement schemes less attractive. On the other hand, reforms of unemployment benefit schemes have been rare. No coun- try has recently carried out reductions in benefit levels and only Denmark has shortened the duration of benefits, although it still remains one of the longest in the EU. Some countries have tightened the eligibility conditions for benefits by requiring appropriate labour market behav- iour (availability to and active seeking for work) and pre- venting the misuse of benefits.
There have been some attempts to increase employment- conditional benefits such as targeted wage subsidies, back-to-work schemes and tax credits on earned income. These reforms have been supportive of active labour mar- ket programmes. In addition, part-time work rather than unemployment has been promoted through a loosening of the conditions for receiving part-time unemployment bene- fits. Nonetheless, the overall shift from passive to active measures has not been strong, and only a few Member States have introduced in-work benefits. Moreover, many new measures, especially those in favour of the young and long-term unemployed, seem to provide only temporary help in terms of better incentives to work. It remains to be seen whether this is sufficient to keep these people in permanent employment or at least significantly longer than the period when the ‘extra bonuses’ are paid. Some Member States have taken steps to tighten the con- trol of eligibility criteria and to create a stricter link between rights and responsibilities, i.e. benefit entitle- ment is linked with requirements for appropriate labour market behaviour (active job search obligations, a stricter definition of ‘suitable work’, participation in active labour market programmes). As a consequence, it has become increasingly difficult for an unemployed person to turn down the offer of a job or a training programme without negative consequences for the entitlement to benefits. For example, Denmark and Finland have introduced rules on the responsibilities of unemployed persons in their legislation especially for young unemployed persons, and have thus tightened the requirement to participate in active measures as a condition for maintaining eligibility for benefits. The Netherlands tightened the application of unemployment benefit sanctions since the mid-1980s. In 1996, legislation was introduced, according to which a voluntary quit or refusal of work or labour market par- ticipation will make the individual ineligible for bene- fits. Also the UK has tightened job availability condi- tions since mid-1980s, including a radical overhaul of benefit legislation in 1996. This legislation creates a framework for processes which define and monitor avail- ability, job-search and compliance with employment services instructions. Furthermore in 1998 under the New Deal, participation in a labour market programme was made obligatory for all youth remaining unemployed after six months plus an additional four-month ‘gateway’ period.
All in all, Member States have made some progress in making the tax system more employment friendly and have started to ease the fiscal burden on labour as well as
reducing marginal tax rates. In benefit systems, the reform effort with a view to improving work incentives has been minor so far. The shift from passive to active measures has been limited and no significant shift to in-work benefits has taken place.
Further reforms should take a more comprehensive approach reviewing the interaction between tax and ben- efit schemes and their joint incentives to work. As regards benefit schemes, they should aim at reducing their over- all generosity, in particular by re-defining the time profile
of unemployment benefits. More generally, further efforts should be devoted to strengthening eligibility criteria (job search and job availability criteria), ensuring their enforcement and the application of sanctions in case of non-compliance or misuse. Strengthening the interaction of benefit provisions with active labour market policies is also warranted. Finally, taxes on labour need to be further reduced and measures targeted at the lowest levels of the income scale need to be carefully designed so as to reduce the unemployment trap while not giving rise to poverty traps for those already in work.
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