Measuring work disincentives: taxes, benefits, and the transition into employment

Disincentives to employment participation arising from the tax-benefit system have been a major concern for welfare reform. Data from the Household, Income and Labour Dynamics in Australia Survey are used to generate and test the robustness of three commonly used disincentive measures for non-working Australians: effective marginal tax rates, replacement rates and participation tax rates. The results of transition models suggest financial disincentives as measured in the current period have a large effect on employment outcomes one year later, and the replacement rate is the preferred measure for modelling disincentives facing the unemployed. While attracting most attention in the welfare-to-work debate, effective marginal tax rates are found to be an inappropriate measure of work disincentives facing the non-employed.