Disincentive to Work? What Work?

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Are you getting tired of unsubstantiated claims that social protection payments are a disincentive to taking up a job?  Me, too.  These assertions pass for informed commentary on the unemployment crisis, using crude calculations and even cruder assumptions about social behaviour.  Let’s throw some light on this dismal debate.

It is claimed that welfare payments make up too high a proportion of take-home pay from work, and that this is stopping people from taking up work.  This, in turn, is helping to maintain high unemployment.  This is called the ‘replacement rate’.  If you earn €100 and social protection payments are €60, the replacement rate is 60 percent.   If the replacement rate is too high, you get disincentives.  When this happens, you have to do something (this usually means cutting social protection payments) in order to reduce the replacement ratio.

Let’s examine the replacement rates from two years – 2012 and 2007.  With the help of the Citizens Information Board’s budget summaries and the TaxCalc calculator I will focus on a two-adult household with three children since the main complaints re: welfare disincentives usually focus on large households.  We will compare them with the household take-home pay on the minimum wage, along with average take-home pay in the retail sector and the overall economy (one work-income earner).

SPRR1

The replacement rates were higher in 2007 than they were in 2012.  With average earnings, social protection payments made up 66 percent of take-home pay in 2007; in 2012 they made up 63 percent.  There were similar falls in the replacement rate for average retail earnings and the minimum wage.

For all households, income from Child Benefit fell.  Average work income flat-lined but net take-home pay fell owing to higher taxation.  This was compensated by increases in the Family Income Supplement.  Social Protection payments, excluding Child Benefit, increased but this was mostly due to Child Dependent Allowances (adult rates only increased only marginally).  Put those all through the mix and we find the replacement rates falling.

The above excludes housing subsidies – notably, rent supplement which creates real traps in the system.  However, were we to include them the replacement rate in 2007 would be even higher than in 2012.  This is because the average rent supplement paid has fallen considerably.  In 2007 the average rent supplement paid was €6,554.  In 2012, it had fallen to €4,819 – a fall of over 26 percent.  In addition, it should be noted that only 11 to 12 percent of the unemployed received rent supplement, so we’re talking about a small proportion.  .

So if the welfare disincentive argument is valid – that ‘high’ social protection payments are preventing people from taking up work –we should have seen this problem in 2007 since replacement rates were higher than they were last year.  We should have seen a situation of relatively high unemployment and vacancies going unfilled.  But what do we find instead?

  • Unemployment rate in 2007:  4.7 percent
  • Unemployment rate in 2012:  14.7 percent

In 2007 the long-term unemployment rate was 1.4 percent; in 2012 it was over 9 percent.

So when the replacement rate was higher we nearly had a full employment economy with one of the lowest long-term unemployment rates in the EU.  Now that replacement rates are lower we have massive unemployment, both short and long-term.

One could be cheeky and suggest an alternative co-relation – the higher the replacement rate, the lower the unemployment rate; therefore, to create incentives to work we should increase social protection payments.  But that would be as invalid as the opposite claim.  There are far more important factors in creating high unemployment – namely, the lack of jobs.  We’ll look at this below but first let’s do some international comparisons.

European Comparisons

Let’s compare the replacement rates for EU countries with much lower unemployment rates than ourselves:  Austria (4.3 percent unemployment), Netherlands (5.3 percent), Germany (5.5 percent), Belgium (7.6 percent) and Finland (7.7 percent); Ireland had an unemployment rate of 14.7 percent and Spain’s rate was 21.7 percent.  If the disincentive to work argument works, we should see those countries with relatively low unemployment to have much lower replacement rates than Ireland and Spain.  What do we find?

SPRR2

We see that, with no housing benefit (e.g. rent supplement), Irish and Spanish replacement rates are below the average of the selected EU countries – in the case of the Irish single person, substantially so.  When we look at replacement rates including housing benefit we find:

SPRR3

With housing benefits – remembering that only 11 percent of the Irish unemployed receive rent supplement –replacement rates are still below selected EU countries, with the exception of a couple with two children which comes in at average.  Again, Spain lags behind other EU countries.

None of this shows that ‘high’ replacement rates are an impediment to taking up work – provided that work is available.  And that is the real issue.

Simple Math

There are two simple formulations that undermine the welfare disincentive argument.  First, there are 32 unemployed for every job vacancy in Ireland.   Cut social protection and living standards of jobseekers all you want and this will not reduce that dismal ratio.  In fact, it is likely to increase it as cutting demand will mean even less consumer activity in the economy.  The Nevin Economic Research Institute shows the vacancy rate in other countries which you can access here (page 33).

And here’s another way to explain unemployment.  The last Quarterly Household National Survey showed that there were 2.171 million in the labour force.  There were 1.870 million in employment.  Subtract the latter from the former and you get 301,000 unemployed.  That’s the surplus.  How does cutting the incomes of the surplus increase the number in employment?

This is something that the school of welfare disincentives fail to address.

The Real Work

How easy it is to look at a problem and say ‘cut it’.  High unemployment?  Cut wages, cut social protection.  It saves one the hard work of addressing the real problems – namely, the low demand for labour.  But even if we focus on the social protection regime itself, there is still the hard work of putting forward concrete proposals.  One could start with the Citizen Information Board’s submission on the topic.  They highlight a number of key areas where work, social protection and taxation interact to create income, poverty and unemployment traps – particularly in the areas where people are trying to combine part-time / atypical work and social protection.

Working hours criteria:  unemployment payments for part-time workers are calculated according to days, rather than hours.  Someone who gets 10 hours’ work per week is treated differently if it the work is spread out over five days as opposed to two (in the former, they get no social protection payment).

Rent Supplement:  the withdrawal of Rent Supplement for anyone working in excess of 30 hours per week can act as a trap.  Some kind of transition period – a tapering over time or over hours – would facilitate this, as would an earnings disregard.

Family Income Supplement:  people must work at least 19 hours a week to be eligible for FIS.  This, along with the administrative delay of up to several months before payment is approved, discriminates against part-time work.

Universal Social Charge:  income below €10,036 is exempt from the USC.  But once it exceeds that threshold, the USC is charged on all income – creating a step effect.  This was introduced by the current Government.

In-work costs:  costs as travel and, especially childcare, makes it costly to take up work.  Travel costs range between €15 and €25 per week, while childcare costs are one of the highest in the EU.

Co-habiting couples:  currently cohabitating couples are treated as a couple for the purposes of social protection but on moving to employment, cohabiting couples are not jointly assessed and do not benefit from the ‘married persons’ tax credits system.

Administrative Delays:  Delays in processing applications means people have to manage on inadequate income – below what they were getting on social protection – while awaiting their payment.  This makes it difficult for people to take up temporary work.

These and a myriad of other issues impact those in low incomes.  People want to work.  When it is available, they’ll take it.  Even if this means they suffer some of the difficulties above.  Yet the debate is dominated by those who, ignorant of what life is like at the cutting edge of unemployment, poverty, atypical work and social protection regulations, make sweeping comments about ‘disincentives’ and call for social protection payments to be cut.

What Is Never Mentioned

As this post has gone on long enough, I won’t go into too much detail about the flip side of the equation – are social protection payments too high or are wages too low?  If one wants to ‘make work pay’, then we need decent wages.  Again, just some quick comparisons in two low-paid sectors – how much of a pay increase (in PPP which removes living standard and currency variations) would Irish workers need to reach different EU averages.

SPRR4

Ireland lags well behind EU averages in both main low-paid sectors.  In the wholesale / retail sector, Irish workers would need a pay increase of between 15 and 32 percent just to reach the average of other EU-15 countries and small open economies respectively (the other small open economies, which is our peer group as they are small economies reliant on the export sector, are Austria, Belgium, Denmark, Finland and Sweden).

In the hospitality sector – hotels, restaurants and pubs – Irish workers would need similar increases to reach the EU averages:  13 to 31 percent.

So the question that should be put on the agenda is whether wages are too low, especially in the low-paid sectors.  This is all the more urgent when one notes that over 27 percent of households with one income suffer multiple deprivation experiences.

* * *

Social protection payments are not a disincentive to work.  Lack of jobs is a disincentive to work.  If we want to help people – rather than hector or label them (e.g. ‘life-style choice’) – we need to raise the demand for labour in the economy , raise wages in the low-paid sectors and create a social protection/taxation system that makes it easy for people to take up work.  We need to provide supports – especially affordable childcare – rather than engage in comfortable armchair lecturing.

And we need to a fact-based debate.  That would be of benefit if only to spare us so much nonsense about welfare disincentives to work.

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