- Measuring work incentives - Work incentives in Finland 1990-2015 - How can we remove unemployment traps? - Work incentives and basic income

1. Olli Kärkkäinen
Seminar on Making work pay
25 May 2016, Brussels
Work incentives and
unemployment traps
– is there an easy cure?

2. OUTLINE
• Measuring work incentives
• Work incentives in Finland 1990─2015
• Three different ways to remove unemployment traps
• Basic income – a miracle cure for work disincentives?
• Basic income experiment in Finland
• What about bureaucracy as a work disincentive?

3. Measuring work incentives
Extensive margin
• Unemployment → employment
• Participation tax rate (PTR)
𝑃𝑇𝑅 = 𝑇 𝑦 − 𝑇 0 /𝑦
• Unemployment trap: PTR > 80 %
• Also: “Bureaucracy trap”
Intensive margin
• Increasing work hours
• Effective marginal tax rate (EMTR)
𝐸𝑀𝑇𝑅 = 𝑇 𝑦2 − 𝑇 𝑦1 /(𝑦2 −𝑦1)
• Low-income trap: EMTR > 70 %

4. WORK INCENTIVES IN FINLAND

5. Work incentives in Finland
• ”Making work pay” has been a goal of all Finnish governments
since the 1990’s
• Focus on unemployment traps
• Main reasons for unemployment traps in Finland
– Housing benefit
– Social assistance
– Earnings-related unemployment benefit

6. Participation tax rates in Finland: 1995−2007
• Average participation tax rate
– 1995: 77,2 %
– 2007: 62,4 %
– Change (2007-1995): -14,8 percentage points
• Reasons
– In-work tax credits (main reason)
– Changes to unemployment benefit legislation
Source: Kotamäki & Kärkkäinen 2014

7. Participation tax rates in Finland: 2011−2015
2011 2015 Change (ppt:s)
Unemployment → Full Time 59,4 % 62,9 % +3,5 %
Unemployment → Part Time 64,2 % 59,7 % – 4,5 %
Part Time → Full Time 54,6 % 66,2 % +11,6 %
Main reasons:
• ↑ Unemployment benefits & housing benefits (2012) =
↓ Work incentives
Source: Kotamäki & Kärkkäinen 2014

8. Participation tax rates in Finland: 2011−2015
2011 2015 Change (ppt:s)
Unemployment → Full Time 59,4 % 62,9 % +3,5 %
Unemployment → Part Time 64,2 % 59,7 % – 4,5 %
Part Time → Full Time 54,6 % 66,2 % +11,6 %
Main reasons:
• ”Protected portion” -reform (2014–2015)
• First 300 €/month of labour income don’t reduce
unemployment benefits or the housing benefit
• Increased work incentives: Unemployment → Part Time
• Reduced work incentives: Part Time → Full Time
Source: Kotamäki & Kärkkäinen 2014

9. HOW CAN WE REMOVE
UNEMPLOYMENT TRAPS?

10. Three ways to remove unemployment traps
1. Cut social security: disposable income as unemployed ↓
+ ”Easy” way of increasing work incentives (cut down costs)
– Poverty, inequality

11. Three ways to remove unemployment traps
1. Cut social security: disposable income as unemployed ↓
+ ”Easy” way of increasing work incentives (cut down costs)
– Poverty, inequality
2. Increase disposable income at part-time work
+ Cost effective way of increasing part-time work incentives
– Decrease work incentives: part-time  full-time

12. Three ways to remove unemployment traps
1. Cut social security: disposable income as unemployed ↓
+ ”Easy” way of increasing work incentives (cut down costs)
– Poverty, inequality
2. Increase disposable income at part-time work
+ Cost effective way of increasing part-time work incentives
– Decrease work incentives: part-time  full-time
3. Increase disposable income of all low-wage workers
+ Increases part-time AND full-time work incentives
– High costs

13. IS UNIVERSAL BASIC INCOME A
MIRACLE CURE?

14. Universal basic income and work incentives
• Basic income
– Unconditional
– Same sum for every adult (regardless of f.e. housing costs)
• Full basic income replaces all current social security benefits
• Partial basic income replaces only some benefits
– f.e. housing benefits and/or earnings related unemployment
benefits would stay in addition to basic income

15. Universal basic income and work incentives
• Full basic income
– Would remove all unemployment traps and make work pay
(depending on the income tax rate)
– Problem: Very high costs (UBI 1500 €/month: income tax rate ≈ 80 %)
or lower social security level
– Compared with current benefits a full basic income would either be
a lot less generous or a lot more expensive

16. Universal basic income and work incentives
• Full basic income
– Would remove all unemployment traps and make work pay
(depending on the income tax rate)
– Problem: Very high costs (UBI 1500 €/month: income tax rate ≈ 80 %)
or lower social security level
– Compared with current benefits a full basic income would either be
a lot less generous or a lot more expensive
• Partial basic income
– Main reasons for unemployment traps remain →
unemployment traps remain
– A budget neutral partial basic income -reform does not increase work
incentives

17. Basic income experiment in Finland
• Government's programme: implementation of a universal
basic income experiment
• Research working group (consisting of f.e. Finnish Social
Insurance Insitution, Research Institutes, Universities)
• Preliminary report (March 2016)
– Compared different basic income models
(and negative income models)
– Suggests trying out an partial basic income (550 ─750 €/month)
– Budget neutral partial basic income reforms would not remove
unemployment traps or work disincentives

18. Basic income experiment in Finland
• Based on the preliminary report, the Finnish Government will
decide on how to proceed with the experiment (Spring 2016)
• Final report of the research working group: November 2016
• Experiment (2017─2018)
– Randomized nationwide sample AND a regional sample to study
externalities
– Sample size depends on the budget

19. BUREAUCRACY TRAPS

20. Bureaucracy traps
• Non-financial disincentives of work
– Working while unemployed requires a lot of paperwork
– Complicated social security systems make things harder
– Uncertainty about how welfare benefits respond to labour
income
• Automating and simplifying the tax-/benefit -system can remove
bureaucracy traps f.e.
– Basic Income
– Universal Credit (UK)
– Universal income registry (Finland 2019)

21. CONCLUSIONS
• Work incentives have increased in Finland since the 1990’s mostly due to
in-work tax credits
• Removing unemployment traps requires either cutting down the level of
social security or very costly tax cuts/social security reforms
• Universal basic income is not a miracle cure for unemployment traps
• Simplifying and automating social security can reduce “bureaucracy traps”

22. Thank you!
Olli Kärkkäinen
Economist
olli.karkkainen@nordea.com