Labour Market Responses to Social Security Contributions and Social Benefits (dissertation)

Abstract

This dissertation focuses on earnings responses to SSC and social benefits which amounted to on average 10.3% and 13.6 % of GDP, respectively, in the OECD countries in 2014. Their large magnitude makes it essential to understand and quantify their impact on labour market outcomes. The four chapters of this dissertation cover the two crucial channels of labour market reactions encompassed in earnings responses: hours of work and compensation per hour. The main joint feature of all chapters is that they look beyond pure labour supply reactions when evaluating social policy and recognise the importance of firms and equilibrium effects. While the research questions analysed are of general interest, the empirical applications are based on German data.The first chapter exploits discontinuities induced by earnings caps for social security contributions (SSC) in Germany to analyse the effect of SSC on gross labour earnings. Empirical evidence is based on two complementary approaches utilising two administrative data sets. First, employment responses to SSC at the intensive margin are identified by a modified bunching approach that is applied to kinks in the budget set generated by the earnings caps. Second, I exploit an increase of a regional earnings cap of health and long-term care insurance as a natural experiment. In order to analyse economic incidence a difference-in-differences approach is used to estimate the effects on gross earnings. I find employment responses to be negligible and the burden of SSC to be shared equally between employers and employees. Both results turn out to be robust and are consistent with a competitive labour market model. The second chapter estimates economic incidence of social security contributions (SSC) on the basis of cross-sectional earnings distributions. The approach exploits discontinuities in earnings distributions at kinks in the budget set which are informative about tax incidence. Contrary to most research on SSC incidence, it does not rely on policy reforms, panel data, or hours information. When the location of kinks does not change significantly, estimates represent equilibrium incidence and are less affected by short-run adjustment frictions than results based on policy reforms. The approach is applied to earnings caps of SSC in Germany where the marginal SSC rate drops to zero. Substantial negative discontinuities are found at most earnings caps of SSC in the distribution of observed net earnings. Together with smooth gross earnings distributions around the caps this provides consistent empirical evidence that legal and economic incidence of SSC coincide. The third chapter extends a static discrete-choice labor supply model by adding participation and hours constraints. Restrictions are identified by survey information providing for a more robust identification of preferences and constraints. Various restriction mechanisms are distinguished and their substantial impact on employment is shown: labour demand rationing, working hours norms varying across occupations, and insuffcient public childcare on the supply side of the market. The empirical framework is applied to evaluate an in-work benefit for low-paid parents in the German institutional context. The benefit is supposed to increase work incentives for secondary earners. The structural model allows for disentangling behavioural reactions into the pure incentive effect and the limiting impact of constraints. The in-work benefit for parents is found to substantially increase working hours of mothers of young children, especially when they have a low education. A standard labour supply model that ignores labour market constraints, however, would yield upward-biased estimates and overstate the benefit's policy impact. Labour supply in the market for low-paid jobs in Germany is strongly influenced by nonlinearities in the tax schedule - even for individuals to whom this tax schedule does not apply. Chapter four presents compelling evidence that an individual's choice set depends on other workers' preferences because firms cater their job offers to aggregate preferences in the market. An equilibrium job search model is estimated which rationalises earnings bunching at a tax discontinuity as firm responses using German administrative data. The model is used to simulate smoothing the tax schedule by reforming the tax and SSC exemption for low earnings in Germany. Results highlight the indirect costs of (discontinuous) tax policies which are shown to be reinforced by firm responses.