Research-based welfare reform By studying how the welfare state affects household behaviour, the EU-funded WSCWTBDS project is helping governments reform their tax and transfer programmes. Society © IhorL, Shutterstock In Europe, much of a government’s activity is related to the welfare state – personal taxation, unemployment benefits, disability insurance, public pensions, etc. The effects of the welfare state are more complex than one might think. For example, income taxes and the provision of benefits reduce the incentive for individuals to seek and retain employment. In other words, if one works, their income is taxed, but if they don’t work, they get benefits – so where’s the incentive for getting to work? At the same time, the value of the welfare state to citizens is significant. After all, it is because of the welfare state that we can depend on financial assistance during old age. The challenge for European policymakers is to balance these costs and benefits, which is exactly what the EU-funded WSCWTBDS project set out to do. ‘Our objective was to provide both theoretical and empirical evidence on how the welfare state affects household behaviour and how governments should design tax and transfer programmes,’ says WSCWTBDS Lead Researcher Guy Laroque. The project’s theoretical work looked at how to design specific features of the welfare state, such as assessing entitlements to benefits. ‘When implementing their redistributive objectives, governments almost always levy taxes and provide transfers that are deterministically conditioned on a set of household characteristics,’ explains Laroque. ‘What we wanted to know was if random transfers could improve outcomes and provide the necessary conditions for the existence of socially-useful randomisations in entitlements.’ What Laroque found was for such a random-based transfer system to work, the potential beneficiaries must be less risk averse than the rest of the population. Turning to the empirical side of the project, researchers tackled questions focused on understanding why individuals make the employment and savings decisions they do. ‘Knowing this can help us understand how an individual would respond to changes in tax and transfer policies,’ says Laroque. The project developed a rich labour supply model to identify why individuals work the number of hours they do. This model separates the number of hours an individual would like to work from the number of hours that an employer allows them to work. ‘This model showed us that, for example, women who are subject to constraints on the number of hours they can work are most likely to belong to significantly poorer households than average and work shorter hours,’ explains Laroque. Researchers also discovered that an individual’s level of patience has an impact on their savings. ‘The more patient an individual is the more likely they will accumulate a financial buffer to protect themselves against life’s risk,’ says Laroque. ‘This in turn has an impact on how the individual will respond to certain aspects of government tax and transfer policies, and public policymakers need to keep this in mind when designing new programmes.’ Keywords WSCWTBDS, welfare state, taxes, pensions, entitlements
