In Germany, both policy makers and researchers have been searching for solutions to overcome the disincentives on labor supply generated by income allowances for welfare recipients (Unemployment Benefit II). Taking proposals of the German Economic Institute (IW) and the governing Liberal Party (FDP) as a starting point, the German Federal Government has intensely discussed this topic during fall 2010 and finally proposed a reform in legislation. In this study, we analyze the potential labor supply effects of the legislated reform and the preceding proposals. In a second step, we augment the different scenarios with a working hours requirement to ensure that only those are subsidized, whose earned income is low due to low hourly wages rather than few working hours. Our simulations confirm the well-known trade-off of in-work benefits: Without working time requirement they tend to create incentives for welfare recipients to increase their labor supply, such that overall labor supply rises. However, the more generous the allowable income regulation, the more expensive the reform gets for the government budget. This comes mainly from the increasing incentive to reduce working hours for those located around the phasing-out level of income. This predominantly affects secondary earners. A working hours requirement reduces these effects and causes more favorable labor market effects and consequently much lower fiscal costs.
© 2014 by Walter de Gruyter GmbH & Co.