On the Welfare Effect of a Wage Subsidy on Youth Labor: Italy’s CFL Program

While a vast literature has analysed the wage and employment effects of active labor market programs (ALMPs), a welfare analysis of such programs is seldom implemented (Kluve and Schmidt, 2002). In an attempt to measure the welfare effect of a wage subsidy on youth labor, this paper performs a rudimentary cost-benefit analysis of Italy’s training and employment enhancing program directed at young workers (CFL, Contratti di Formazione e Lavoro). In particular, the analysis highlights the fact that the welfare effect of a targeted wage subsidy – in the form of a payroll tax rebate for firms employing youth labor – crucially depends on whether the labor market is affected by previous fiscal distortions generated either by the absence of linkage between payroll tax revenues and workers’ benefit, or by the presence of a wage floor. Based on reasonable estimates of youth labor demand and labor supply elasticities, it turns out that, in the absence of linkage between payroll tax revenues and benefits to young workers, the introduction of a 15% wage subsidy can be expected to generate a small employment gain (1 to 3 percentage points), and a net welfare gain – measured by the Marshallian approximation of employers’ and workers’ surplus – of less than €30 million (around 5% of the total cost of the welfare programme, amounting to almost €600 million), that could well be offset when the general equilibrium consequences of the selective wage subsidy are allowed for (substitution of non-eligible workers). On the other hand, in the presence of a wage floor that equals the current wage of young CFL workers, and a status quo youth involuntary unemployment rate of 18%, it is estimated that the 15% wage subsidy can generate a youth employment rise of up to 15 percentage points, and a net welfare gain of over €300 million – almost 50% of the total cost of the welfare programme.