How European Welfare Discourages Work

By Michael D. Tanner and Charles Hughes

This article appeared on Politico Europe on August 28, 2015.

In 2013, the New York Times reported on the case of Carina, a 36-year-old Danish single mother who had been on welfare since she was 16. Denmark has long had one of the most generous welfare systems in Europe, and Carina was able to collect more than €2,300 per month in benefits, an amount that enabled her to live quite comfortably without working.



A second welfare recipient discussed in the article, Robert Nielsen, had been supported by the government for more than a dozen years. He had not attempted to find work and did not intend to. As he said, “Luckily, I am born and live in Denmark, where the government is willing to support my life.”
A new study by the Cato Institute suggests that, in far too many European countries, these might not be isolated cases. Social welfare benefits may be so high, compared to what a low-skilled worker could expect to earn from an entry-level job, that they discourage work.
Using data available from the European Commission and the Organization for Economic Cooperation and Development (OECD) for 2013, we looked at the case of a typical single mother with two children in 23 EU countries, focusing on four benefits in four broad categories: social assistance, housing assistance, family and child benefits, and tax credits.

This hypothetical parent could receive total benefits worth more than €15,000 per year in nine countries. In six countries, benefits exceeded €20,000 (Austria, Denmark, Finland, Ireland, the Netherlands, and the United Kingdom). In fact, in Denmark, the most generous country, the potential benefit package exceeded €31,709 per year.
In nine countries, welfare benefits exceeded the gross income from minimum wage in that country.
Low-income people participating in these programs respond to incentives, just like everyone else. When benefit levels get this high, they can create a significant disincentive to work, especially since someone leaving welfare for work not only loses benefits, but must also begin to pay taxes and incur other associated costs.
Economists often worry about high marginal tax rates for businesses or the wealthy. But some of the world’s highest effective marginal tax rates are actually applied on a poor person who leaves welfare for a job.
In Austria, Croatia, and Denmark, for example, the effective marginal tax rate for someone leaving welfare for work is nearly 100 percent, meaning that a person would gain virtually no additional income from working, after accounting for increased taxes and reduced benefits. In another 15 countries, individuals would face an effective marginal tax rate in excess of 50 percent.
Up the ladder
Work disincentives of this magnitude are problematic for several reasons. First, they erode social solidarity, by breaking the implicit contract with recipients that they take steps that would enable them to become self-supporting as soon as possible. Such a requirement is not merely a question of moral sentiment and reciprocity. The perception that recipients are content to live off of others, accurate or not, is likely to undermine political support for the program.
Second, to the degree that generous benefits encourage otherwise-able workers to drop out of the labor force, it slows economic growth, making everyone a little bit poorer.
But most importantly, if our goal is to actually help the poor escape poverty, we know that work is one of the ways to achieve that goal. In the United States, for the working age population, only 2.7 percent of full-time year-round workers were poor in 2013. Even part-time work makes a significant difference. Only 17.5 percent of part-time workers were poor, compared with 32.3 percent of working-age adults who do not work.
The evidence strongly suggests that once individuals start a job, even an entry-level one, they move up the income ladder. Therefore, work should be at the center of any anti-poverty policy. Helping as many people as possible move from welfare to work would reduce poverty and increase economic mobility. Yet the high level of benefits available in many EU countries moves recipients in exactly the opposite direction.
Fortunately, many European countries, notably Croatia, Lithuania, Ireland, and the United Kingdom, have recognized the problem and have begun to reform their welfare systems to create a better transition from welfare to work. Indeed, several EU countries may be doing more to reform welfare than the United States.
But for the most part, EU nations still fall short of establishing a clear public policy preference for work over welfare. Countries that are serious about reducing welfare dependency and rewarding work should consider strengthening work requirements, establishing time limits for participation, and tightening eligibility.
Perhaps more importantly, countries should examine the level of benefits available and the effective marginal tax rates their welfare systems create, with an eye toward reducing disincentives and encouraging work.