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The Transition from Welfare to Work and the Role of Potential Labor Income

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The Transition from Welfare to Work and the Role of Potential Labor Income

Hilmar Schneider (IZA, DIW Berlin)

Arne Uhlendorff (DIW Berlin, IZA)

The Transition from Welfare to Work and the Role of Potential Labour Income

- Introduction
- Literature
- Social assistance in Germany
- Data & Methodology
- Results
- Conclusion

Introduction

Aim of the Study:

Estimating the Effect of the Ratio between the potential labor income and the amount of social assistance on the probability of a transition from welfare to work

Data: GSOEP 1992-2000

Methodology:

Discrete time Hazard Rate Models with competing risks

Literature

- Income variables usually not considered (Gangl 1998 or Voges and Rohwer 1992)
- Wilde (2003): Difference between social benefits and the average income for unskilled employees
- Riphahn (1999): No effect of a predicted real net income variable
- North American studies usually find negative effects of the amount of benefits (Hoynes and Macurdy 1994 orFortin et al. 2004)

Social Assistance in Germany

- Means-tested transfer program
- In principle, everybody in need is eligible
- The amount is related to a basic minimum income concept depending on household composition
- fills the gap between own income and the maximum benefit for the household
- Labour income up to 25% of the basic allowance is not taken into account, additional income is deducted at an implicit marginal tax rate from 85 – 100%

Social Assistance in Germany

- Static labor supply theory: Participation probability increases with the amount of benefits
- Dynamic Job-Search model: reservation wage depends positively on the amount of benefits
- Hypothesis: Higher ratio between expected wage and benefits Higher transition probability

Derives a higher transition probability from a higher acceptance probability or from a higher job offer arrival rate?

Data

- GSOEP waves 1992-2000
- 579 welfare spells between January 1991 - December 1999; 455 households
- 386 uncensored, 193 right-censored cases
- 199 transitions to work, 187 alternative transitions
- Transition to work: at least one adult household member working fulltime, both working part-time, single household: One person working part-time

Potential Net-Income and Social Assistance

Estimation of gross market wages of all heads of the household and their partner

2.Potential net income: Highest gross income accounting for income taxes, social security contri- butions and child allowance

3.Amount of social assistance: calculate the maximum of social assistance

4.Calculation of the ratio between potential labour income and social assistance

Estimation of the hourly gross wage

Wage equation

Selection equation

Pooled sample using the GSOEP waves 1991-1999

Distribution of the income ratio

Ratio 1: takes on the ratio value if the ratio is below 1 (25%)

Ratio 2: takes on the ratio value if the 1 < ratio < 1.5(45%)

Ratio 3: takes on the ratio value if the ratio is above 1.5 (29%)

Model Specification

- Monthly data discrete hazard rate models
- Assumption of an underlying continous time proportional hazard rate
- Interval constant covariates and baseline transition rates
- Competing risks: Employment and Alternative transitions
- Unobserved heterogeneity: bivariate normal distribution

Random Effects Piecewise Exponential Model

Random Effects Piecewise Exponential Model

Hazard rate:

Risk-specific Transition rate:

Survivor Function:

Transition Probability:

Destination-specific components have to be maximized jointly.

Results

- Ratio between potential labour income and welfare level: positive effect for ratios above 1
- Interpretation of coefficients:

1< income ratio<1.5 : + 0.1 + 10% trans. prob.

1.5 income ratio: + 0.1 + 7% trans. prob.

- No influence on the probability of alternative transitions

Summary and Conlusions

- In contrast to previous studies we identify an effect of the income ratio on the probability of transition from welfare to work
- This „new“ result derives from a consideration of both sources of income and from a differentiation between transitions to work and alternative transitions.
- Incentive effects seem to be of prior relevance

Future Research

- What are the alternative transitions besides from welfare to work?

- Which income situations do we observe following a transition to work?

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