Getting the Poor to Work: Three Welfare Increasing

We study three budget-neutral reforms of the German tax and transfer system designed to im-prove work incentives for people with low incomes: a feasible flat tax reform that provides a basic income which is equal to the current level of the means tested unemployment benefit, and two alternative reforms that involve employment subsidies to stimulate participation and full-time work, respectively. We estimate labor supply reactions and welfare effects using a microsimula-tion model based on household data from the Socio-Economic Panel (SOEP) and a structural labor supply model. We find that all three reforms increase labor supply in the first decile of the in-come distribution. However, the flat tax scenario reduces overall labor supply by 4.9%, the reform scenario designed to increase participation reduces labor supply by 1%, while the reform that pro-vides improved incentives to work full-time has negligible effects on overall labor supply. With equal welfare weights, aggregate welfare gains are realizable under all three reforms