Reforming Social Welfare as We Know It? A Microsimulation Study for Germany

Social assistance and unemployment assistance, which provide means tested income support (social welfare) without pre-specified time limits, are viewed as one important reason for the persistently high level of unemployment in Germany by many economists. In order to increase work incentives and, at the same time, reduce social expenditures there have been various proposals to reform social welfare in the recent German policy debate. We analyse a specific reform proposal with the following components: (i) an integration of unemployment assistance and social assistance; (ii) a substantial reduction of the social assistance level for ?employable? persons who choose not to work; (iii) improved incentives to take up work by a combination of a reduction of the social assistance withdrawal rate and an earnings-related tax credit. The expected employment and fiscal effects of this welfare reform proposal are simulated on the basis of an econometrically estimated partialequilibrium labour supply/demand model embedded in a detailed tax-benefit microsimulation model. We find that the reductions in net social expenditures may be substantial, although the expected labour supply and employment effects of this reform are much smaller than is typically assumed by contributors to recent discussions on the potential labour market effects of welfare reforms in Germany. Furthermore, these employment gains come at the cost of a substantial expansion of public-works jobs.