samlet årgang - Økonomisk Institut - Københavns Universitet

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NATIONALØKONOMISK TIDSSKRIFT 2005. NR. 3
nothing for the rich to give money to the working poor – implying that the reform is
(almost) Pareto improving. For a number of other countries, the working poor policy
creates very small efficiency losses such that the trade-off is quite close to one. This
applies to countries such as Austria, Greece, Luxembourg, the Netherlands, and
United Kingdom. In these countries there is no significant trade-off between efficiency
and equality when we consider redistribution from the rich to the working poor.
Only in the case of Finland and Sweden does the working poor policy involve an unfavorable
equity-efficiency trade-off, which reflects in part the extremely equal earnings
distribution in these two countries.
A comparison of Table 1 and 2 reveals that countries with relatively high participation
tax rates at the bottom of the earnings distribution, such as Denmark, Ireland
and France, tend to gain more by choosing a working poor policy rather than a traditional
welfare policy. The working poor policy creates higher incentives for participation
in the labor force. Moreover, participation increases mainly at the bottom deciles
where participation elasticities are large. If participation tax rates are very large at
the bottom deciles, the increase in labor market participation creates a large increase
in government revenue (through reduced benefit expenditures and a higher tax take)
and hence in economic efficiency.
Ceteris paribus, the presence of a highly equal pre-tax earnings distribution tends to
make redistribution very costly. This applies to redistributional policies in general, and
to the working poor policy in particular because it attempts to redistribute only within
the group of workers who are more equal than the entire population of workers and
non-workers. The presence of strongly compressed wage distributions in Scandinavian
countries (cf. Table 1) is often mentioned as an argument against pursuing in-work
benefit reforms in this region. It is therefore interesting that the working poor policy
seems to be extremely desirable in Denmark, more so than in any other country. The
explanation is that participation tax rates are very high in Denmark, especially in the
bottom deciles where participation elasticities are also high. In the simulations, this effect
strongly dominates the effect of a compressed earnings distribution. On the other
hand, the working poor policy is less desirable in Finland and Sweden, because participation
tax rates at the bottom are somewhat lower there and because the earnings
distribution is even more equal than in Denmark. It is important to realize, however,
that the equity-efficiency trade-off is even worse for the traditional welfare policy in
Finland and Sweden. The bottom line is that both kinds of redistribution are very costly
in these two countries, at least on the margin, due to the combination of an already
equal distribution and high tax rates.
Besides the presence of an equal earnings distribution, a potential argument against
working poor policies in Scandinavia is that participation elasticities might be signifi-