1/17 The Transition from Welfare to Work and the Role of Potential Labor Income Hilmar Schneider (IZA, DIW Berlin) Arne Uhlendorff (DIW Berlin, IZA)

2/17 The Transition from Welfare to Work and the Role of Potential Labour Income –Introduction –Literature –Social assistance in Germany –Data & Methodology –Results –Conclusion

3/17 Introduction Bill. € Figure 1: Development of the expenditures for social assistance in Germany

4/17 Aim of the Study: Estimating the Effect of the Ratio between the potential labor income and the amount of social assistance on the probability of a transition from welfare to work Introduction Data: GSOEP Methodology: Discrete time Hazard Rate Models with competing risks

5/17 Literature  Income variables usually not considered (Gangl 1998 or Voges and Rohwer 1992)  Wilde (2003): Difference between social benefits and the average income for unskilled employees  Riphahn (1999): No effect of a predicted real net income variable  North American studies usually find negative effects of the amount of benefits (Hoynes and Macurdy 1994 or Fortin et al. 2004)

6/17 Social Assistance in Germany  Means-tested transfer program  I n principle, everybody in need is eligible  The amount is related to a basic minimum income concept depending on household composition  fills the gap between own income and the maximum benefit for the household  Labour income up to 25% of the basic allowance is not taken into account, additional income is deducted at an implicit marginal tax rate from 85 – 100%

7/17 Social Assistance in Germany  Static labor supply theory: Participation probability increases with the amount of benefits  Dynamic Job-Search model: reservation wage depends positively on the amount of benefits  Hypothesis: Higher ratio between expected wage and benefits  Higher transition probability Derives a higher transition probability from a higher acceptance probability or from a higher job offer arrival rate?

8/17 Data  GSOEP waves  579 welfare spells between January December 1999; 455 households  386 uncensored, 193 right-censored cases  199 transitions to work, 187 alternative transitions  Transition to work: at least one adult household member working fulltime, both working part-time, single household: One person working part-time

9/17 Potential Net-Income and Social Assistance 1. Estimation of gross market wages of all heads of the household and their partner 2.Potential net income: Highest gross income accounting for income taxes, social security contri- butions and child allowance 3.Amount of social assistance: calculate the maximum of social assistance 4.Calculation of the ratio between potential labour income and social assistance

10/17 Estimation of the hourly gross wage Wage equation Selection equation Pooled sample using the GSOEP waves

11/17 Distribution of the income ratio Ratio 1: takes on the ratio value if the ratio is below 1(25%) Ratio 2: takes on the ratio value if the 1 < ratio < 1.5 (45%) Ratio 3: takes on the ratio value if the ratio is above 1.5 (29%)

12/17 Model Specification  Monthly data  discrete hazard rate models  Assumption of an underlying continous time proportional hazard rate  Interval constant covariates and baseline transition rates  Competing risks: Employment and Alternative transitions  Unobserved heterogeneity: bivariate normal distribution  Random Effects Piecewise Exponential Model

13/17 Random Effects Piecewise Exponential Model Hazard rate: Risk-specific Transition rate: Survivor Function: Transition Probability:  Destination-specific components have to be maximized jointly.

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15/17 Results  Ratio between potential labour income and welfare level: positive effect for ratios above 1  Interpretation of coefficients: 1< income ratio<1.5 :  + 10% trans. prob. 1.5 income ratio:  + 7% trans. prob.  No influence on the probability of alternative transitions

16/17 Summary and Conlusions  In contrast to previous studies we identify an effect of the income ratio on the probability of transition from welfare to work  This „new“ result derives from a consideration of both sources of income and from a differentiation between transitions to work and alternative transitions.  Incentive effects seem to be of prior relevance

17/17 Future Research - What are the alternative transitions besides from welfare to work? - Which income situations do we observe following a transition to work?