Wolfgang Franz

Nicole Guertzgen

Stefanie ; Schubert

Markus Clauss

Otto

Assessing the Employment Effects of the German Welfare Reform -An Integrated CGE-Microsimulation Approach

Keywords: D58 -Computable and Other Applied General Equilibrium Models < D5 Microsimulation, CGE-Modelling, Labour Supply, Trade Unions Microsimulation, CGE-Modelling, Labour Supply JEL-Code: H31, D58, J22

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Introduction

In recent decades, the German economy has experienced a substantial increase in unemployment among low-skilled workers. In 2004, the unemployment rate among individuals with no formal vocational qualications was 22 per cent in western Germany and about 52 per cent in eastern Germany (IAB 2007). Against this background, the German welfare system, comprising the means-tested benets of social assistance and unemployment assistance, has been a target of frequent criticism for hindering the integration of the low-skilled unemployed into the labour market. The rationale underlying this criticism is that generous benet levels and high transfer withdrawal rates are widely perceived as creating substantial labour supply disincentives, particularly for those with low earnings perspectives. These discouraging eects have led economists and politicians to advocate programmes intended to improve work incentives. On January 1st 2005, the German welfare system was fundamentally reformed by the "Fourth Law for Modern Services in the Labour Market", commonly referred to as the "Hartz IV" reform. A key element of this reform was to merge the coexisting transfer systems of social assistance and unemployment assistance into one unied benet known as "Unemployment benet II" (Arbeitslosengeld II -ALG II). Regular unemployment insurance benets were not immediately aected by this legislation. While the reform partly entailed a signicant cut in benets -especially for those formerly entitled to unemployment assistance -high transfer withdrawal rates remained largely unchanged.

The purpose of the present paper is to quantify the employment eects associated with this recent welfare reform. Using an integrated CGE-microsimulation approach, we study two scenarios: the ALG II scenario which illustrates the effects of the new legislation and a second reform scenario that is meant to further improve the labour supply incentives for low-skilled workers. In recent years, microsimulation models have become an increasingly popular way of quantifying the employment eects of labour market reforms in the low-wage sector (e.g., Buslei and Steiner 1999, Bonin et al. 2003, Bargain and Orsini 2005, Immervoll et al. 2007, Haan and Steiner 2008). Such simulations are typically based on the estimation of a discrete choice labour supply model, in which households make decisions about their labour supply choosing from a nite set of working-time categories (van Soest 1995). Microsimulations based upon discrete choice models not only allow for a straightforward distinction between labour supply eects along the extensive and intensive margin but additionally facilitate the representation of complex tax-transfer reg- ulations since the latter have to be calculated for a nite set of hours only. The key advantage of such models therefore is that they allow researchers to account for the large amount of heterogeneity in terms of households' preferences and budget constraints. Nonetheless, when relying on microsimulation studies, researchers face further important challenges in obtaining a credible ex-ante assessment of the expected employment eects. One obvious drawback of microsimulation models is that they remain conned to labour supply eects and usually neglect a reform's impact on labour demand and wage determination. It is very dicult to ignore such eects, however, when a reform concerns a large number of people. In this case, participation and labour supply responses may be expected to aect the labour market equilibrium through the adjustment of wages and unemployment as well as the need to balance the public budget, which in turn gives rise to feedback eects on labour supply. General equilibrium feedback eects are especially relevant in our case, since the reforms considered here aect a large number of individuals directly and a considerable number of individuals indirectly, e.g. by altering the breakeven points, i.e. the threshold income at which individuals are no longer eligible for benets.

To account for potential general equilibrium repercussions, the present paper adopts an integrated micro-macro approach. The model we use provides a linkage between a computable general equilibrium model and a microsimulation model, which represents a further development of the CGE model PACE-L (Böhringer et al. 2005, Boeters et al. 2005, 2006, Arntz et al. 2006, 2008). The CGE model incorporates important institutional features of the German labour market, such as sectoral wage-bargaining between unions and employers' associations, as well as sectoral labour-demand decisions. Compared with standard microsimulation models, such an integrated model therefore enables us to simulate not only labour supply eects but also the employment and wage eects resulting from our reform scenarios.

The remainder of the paper is structured as follows: Section 2 provides a description of the German welfare system before and after the introduction of ALG II. Given the remaining labour supply disincentives, we present a second reform scenario that is intended to improve participation incentives. Section 3 outlines the main methodological approach and provides a description of the integrated CGEmicrosimulation model. Section 4 presents the simulation results of the employment eects following the introduction of ALG II and our reform scenario. The nal Section 5 concludes. As of 1 January 2005, social assistance and unemployment assistance were abolished and both elements of these previous systems merged to create 'unemployment benet II' (ALG II). The regular "unemployment benet", which is paid for a maximum of 32 months, provided the requirements are met, has not been aected by the ALG II reform. In the next sections, we provide some institutional background information and illustrate the key labour supply disincentives associated with these transfers.

Social Assistance

Social assistance (SA) was a means-tested transfer programme that was targeted at people for whom the other transfer systems, such as unemployment benets and unemployment assistance, did not provide sucient income support. In particular, eligibility for SA payments required that income from other sources fell short of some specied basic minimum income level. As a result, households receiving transfer payments from other sources were also eligible for supplementary SA if those transfers were smaller than the specied minimum income. While SA recipients were allowed to retain a small fraction of earned labour incomes, income from other sources was deducted in full. SA payments established a minimum income that consisted of a basic rate ("Regelsatz") for the head of the household and age-dependent rates for each additional household member as well as a housing allowance for rent and heating costs. The monthly basic rates for the head of the household was 296 e, on average, in western Germany and 283 e in eastern Germany, respectively. 1

Unemployment Assistance

Unemployment assistance (UA) was available to those unemployed claimants who had exhausted their unemployment insurance benets. Contrary to unemployment insurance benets, unemployment assistance required a means-test of household income and wealth and was usually paid for an unlimited period of time. The replacement ratio was 53 per cent of insured labour earnings or, alternatively, 57 1 For children up to 7 years the basic rate amounted to 50 per cent of the standard basic rate (for single parents 55 per cent), for children from 7 to 14 years the fraction was 65 per cent, and for children from 14 up to 18 years 90 per cent. (Married) partners have been granted 80 per cent of the standard rate. per cent, if children were present. UA recipients whose benets fell short of the SA minimum income were entitled to supplementary social assistance.

ALG II

When the "Fourth Law for Modern Services in the Labour Market" came into eect on 1 January 2005, social assistance and unemployment assistance were replaced by 'unemployment benet II' (ALG II) as a unied welfare system targeted towards employable individuals. 2 A key element of the introduction of ALG II is that benets are no longer tied to former labour earnings as was the case with unemployment assistance. Instead, the design of ALG II largely followed the set-up of the former social assistance system providing a basic rate as well as housing and heating costs. Compared with the former SA minimum income, the basic rate under ALG II has been slightly increased: for example, for western (eastern) Germany the rate was 345 e (331 e) in 2005. This increase arises from the fact that SA benets for specic needs which were formerly granted on a discretionary basis have been replaced by a at amount. Partners and children older than 14 years receive 80 per cent of the basic rate, while children up to 14 receive 60 per cent. The rules for earnings allowances are fairly similar to the former social assistance regulations (see Section 2.4.2 below). However, an important dierence is that ALG II has a more generous wealth test. 3

Labour Supply Disincentives

The German social assistance and unemployment assistance system has been widely criticised for creating labour supply disincentives for two reasons: First, the gap between the potential labour earnings of a transfer recipient and the minimum income level is usually considered too small. The major reason is that the skill-level of recipients is typically low, which considerably reduces their earnings perspectives in the labour market. 4 Second, recipients generally face high eective marginal tax rates as a result of the tapering of benets. In the next sections, we illustrate the disincentive eects arising from the narrow gap between transfers and potential labour earnings and high transfer withdrawal rates. Moreover, we examine the extent to which the introduction of ALG II may have contributed to improving the incentives to participate in the labour market.

Wage-Assistance Dierentials

To illustrate the narrow gap between potential labour earnings and benets, Table 1 displays wage-assistance dierentials for dierent household types. This dierential measures the amount by which potential disposable labour income (column (3)) exceeds the respective minimum incomes (column (1) and ( 2)) in percentage terms. The calculations are performed on the basis of a full-time job of 38 hours per week in the low-wage sector. 5 For couples, only one of the partners is assumed to work in the low-wage sector while the spouse receives no labour or transfer income. The dierentials reported in columns (4) of Table 1 reveal that the gap between disposable labour income and SA income ranged between 6.8 and about 76 per cent. Moreover, the dierential generally decreased with the number of children. Single parents and couples with more than two children exhibited a dierential of less than 10 per cent. This was primarily caused by the fact that average basic SA rates for children exceeded child benets available to those individuals who were not entitled to SA payments. Column (2) shows the minimum income under ALG II, column (5) the respective dierentials. The gures show that the introduction of ALG II has led to a slight decrease in the wage-assistance dierential which mainly arises from replacing one-time payments by at amounts. 6 Taken together, Table 1 suggests that both the SA and the ALG II minimum income levels create considerable labour supply disincentives, particularly for low-income workers with children.

Transfer Withdrawal

According to the unemployment assistance regulations, additional labour earnings exceeding an exemption of 20 per cent of the benet level -but no less than 165 e -were entirely taxed away. Further, people working for 15 hours or longer a week were no longer eligible for unemployment assistance. The solid budget line in the upper panel of Figure 1 shows the relationship between gross labour earnings and disposable income for a single person without children. disincentives for recipients with relatively high former earnings, who currently face low earnings perspectives, we assume a former net earnings level of 1,900 e and a potential gross hourly wage of 8.50 e. The budget line shows that in this case the incentive to take up a job required a gross monthly income of at least 1,500 e. Figure 1 thus demonstrates that the design of unemployment assistance created substantial disincentives for those individuals with relatively high former earnings who experienced a large human capital depreciation.

Under the means-tested social assistance regime, eligibility was contingent on recipients' inability to cover their needs from their own income or wealth. Thus, similar to unemployment assistance, SA benets were subject to large transfer withdrawal rates of up to 100 per cent. More specically, labour earnings which exceeded an exempted 25 per cent of the basic rate were withdrawn at a rate of 85 per cent. The maximum exemption amounted to 50 per cent of the basic rate. The solid line in the lower panel of Figure 1 shows the budget line for a (potential) single SA recipient without children. 7 For this household type, the breakeven point, i.e. the point at which individuals were no longer eligible for assistance, was reached at gross earnings of about 1,000 e. In sum, the two graphs demonstrate that both systems discouraged labour supply over a wide range of gross labour earnings particularly for those persons with a very low income potential.

F

The dashed lines in Figure 1 represent the introduction of ALG II. Gross earnings exceeding an exemption of about 100 e are taxed away at a rate of 80 per cent up to a threshold level of 800 e and at a rate of 90 per cent between 800 and 1,200 e gross labour earnings (for households with children up to 1,500 e). Figure 1 thus demonstrates that transfer withdrawal regulations under ALG II led only to a slight increase in the participation incentives for former SA recipients. Further, it can be seen that the breakeven point has been raised. For former recipients of unemployment assistance, in contrast, the upper panel of Figure 1 shows that the ALG II regulations led to a substantial increase in the incentives to take up a part time job since the large discontinuity in the budget curve owing to the 15-hours regulation has been removed.

Modied ALG II

The second scenario basically follows several reform proposals that have been advocated in the recent political discussion in Germany (e.g., German Council of Economic Experts 2006). The common features of these proposals consist in the reduction of marginal tax rates in the lower income ranges associated with a decrease in the minimum income guarantee. Starting from the introduction of ALG II, our second scenario therefore aims at widening the gap between benets and potential labour earnings and at reducing transfer withdrawal rates. More specically, basic rates for household heads and their partners are cut by 50 per cent. Such a strong reduction in benet levels immediately raises the question as to how the reform can be reconciled with the current constitutional welfare state principle. In legal terms, any decrease in benet levels ought to be defendable if ALG II recipients are able to sustain their present level of income support, either by taking up employment in the primary labour market with supplementary ALG II, or by being assigned to a so-called "working opportunity". The functioning and the various types of these opportunities are discussed elsewhere (German Council of Economic Experts 2006). In our simulations, we assume -for the sake of simplicity -that such opportunities can be provided in a cost-neutral manner. As the reform is generally targeted at employable persons, certain groups of individuals are excluded from our reform scenario. [START_REF] Boeters | Reforming Social Welfare in Germany An Applied General Equilibrium Analysis[END_REF] Further, the basic exemption is abolished and transfer withdrawal rates are reduced to 50 per cent for all households which are subject to the cut in benet levels. [START_REF] Bonin | Household Labour Supply Eects of Low-Wage Subsidies in Germany[END_REF] The dotted lines in Figure 1 depict the relationship between gross earnings and disposable income for this modied ALG II scenario. The budget lines show that the reform entails a sizeable income eect not only for former recipients of unemployment assistance but also for former SA beneciaries. Moreover, the budget lines show that for both groups the reform is likely to increase the incentive to take up a part time job. 3 The Microsimulation-CGE Model The microsimulation model is based on individual household data taken from the German Socio-Economic Panel Study G-SOEP, a representative household survey for Germany. The data refer to the benchmark year 2004, with social assistance and unemployment assistance constituting the prevailing welfare system. The microsimulation model covers all households with exible time allocation and observable hours of work. Pensioners, students, women on maternity leave, civil servants and the self-employed are assumed to be inexible and are excluded from our simulations, since they are not expected to change their labour supply behavior in response to the reforms considered here. Accounting for single and couple households, this results in four dierent household types: exible singles, exible couples, "mixed" couples consisting of a exible and an inexible spouse and, nally, one household type comprising all those households which include only inexible members. This latter household type is not considered in our simulations. Moreover, the labour supply of further household members is assumed to be constant. Following van Soest (1995), we use a discrete choice model of labour supply in which each individual chooses from a nite set of working-time categories: Underlying our simulations is a set of ve working-time categories for singles (0, 15, 30, 38, or 47 hours per week), which results in 25 working hours combinations for couple households. Such a discrete choice approach has the advantage of allowing for a straightforward distinction between labour supply eects along the extensive and intensive margin. Moreover, it provides a more realistic description of labour supply options as we do not generally observe innitesimal changes of working hours but rather a concentration of hours at particular working hours categories.

At the heart of the discrete choice approach is the assumption that a single household chooses the working-time category which maximises its individual utility. Similarly, a couple household chooses the labour supply combination maximising a joint utility function. Underlying this assumption is the so-called unitary approach of household behaviour (see Blundell and MaCurdy 1999). Choosing the zero-hours option is viewed as reecting voluntary unemployment. Households' preferences are represented by a translog utility function U of household j depending on the number of hours h k in category k. The category combination (k, l) represents the choice of couples with the woman selecting h f k and the man choosing h m l hours of work:

U j (x jk ) = x jk • A • x jk + β j • x jk . ( 1
)
The argument vector x jk of the utility function includes the logs of disposable household income y jk and weekly hours of leisure for men m and women f , respectively,

x jk = (log(y j (h f jk , h m jl )), log(T -h f jk ), log(T -h m jl )),
where T denotes the time endowment which is taken to amount to 80 hours a week. A is a 3×3-matrix containing the coecients of the quadratic terms, while β j represents the coecients of the linear terms. Extending the utility function by an error term, the parameters in equation ( 1) can be estimated using a conditional multinomial logit model. The error term is assumed to be independently standard extreme-value distributed. According to the seminal contribution of McFadden (1974), the probability for singles (couples) of preferring option k (combination (k, l))10 over all other options m = k is given by the following expression:

F o r P e e r R e v i e w P (U jk > U jm ) = exp(U j (x jk )) l exp(U j (x jl )) , m = k. ( 2
)
The maximum likelihood estimation results based upon actual labour supply and disposable incomes in 2004 can be found in Appendix A1-A4. [START_REF] Clauss | Distributional and Behavioural Eects of the German Labour Market Reform[END_REF] The parameters include interactions between leisure, income and a set of household characteristics. These interactions account for dierences in the preferences of households for certain hours of work options. In addition, constant terms are included to capture xed costs of working.

The Budget Constraint

In addition to the labour supply module, the microsimulation model contains a tax-benet calculator, which provides a detailed representation of the German taxtransfer system. As mentioned earlier, a key advantage of the discrete choice set-up is that it considerably facilitates the incorporation of complex tax-transfer regulations since the latter are to be calculated for a nite set of hours only. In the context of our discrete choice set-up, the budget constraint needs to be determined for all hours categories in the status quo year 2004 and the reform scenarios described in Section 2.4.2 and 2.5. To obtain disposable incomes, each household's gross earnings are derived from multiplying individual gross hourly wages with hours. Since gross hourly wages are unobservable for those who are not employed, wages have to be estimated using a Mincer-type wage regression with education, experience and some further controls (e.g. nationality, marital status). We use Heckman's (1979) selectivity correction to account for the positive selection of employed individuals for whom wages are observed. Other sources of income, such as income from rents, are added to labour earnings. Net monthly incomes are calculated by deducting income taxes and social security contributions from gross monthly incomes according to the German tax system. Finally, disposable monthly incomes are obtained by adding transfer payments. When determining the entitlement to social assistance, unemployment assistance and ALG II, we further attempt to account for household wealth. A detailed description of the German tax-transfer system is given in Appendix A.2. Later, for the policy simulations, we use a rst-order approximation of the tax-transfer system. This is done by disturbing the calculations of disposable [START_REF] Clauss | Distributional and Behavioural Eects of the German Labour Market Reform[END_REF] Individual labour supply observed in the data is matched to the working-hour categories used in our model as follows: 0 < h < 22.5 : 15 hours, 22.5 ≤ h < 34 : 30 hours, 34 ≤ h < 42.5 : 38 hours, and h ≥ 42.5 : 47 hours. income marginally at all relevant points to calculate numerically the local eective marginal burden of the total tax-transfer system.

Simulation Method

Given the individual parameters of the utility functions and expected disposable incomes for the pre and post-reform situation, we can proceed to simulate labour supply eects. In this regard, there are dierent simulation mechanisms that have been proposed in the literature. A rst possibility is to use the probabilities predicted by the conditional logit model in order to calculate each household's expected working hours in the pre and post-reform situation. The disadvantage with this procedure is that it is not possible to calculate transition probabilities conditional on status quo labour supply. As we are particularly interested in the labour supply responses of those individuals who do not participate in the benchmark, we opt for the method proposed by Duncan and Weeks (1998) (see also Creedy and Kalb 2005). The Duncan-Weeks simulation method exploits the fact that we have information about the choices of the households in the initial situation. This information can be used to transform the utility evaluations of the disposable incomes into conditional probabilities. To do so, we take independent random draws from an extreme-value distribution, which are added to the deterministic part of the utility function (1). We retain only those random numbers that maximise pre-reform utility at the observed working hours. For each household, we retain 100 random numbers for each working hours category (or combination). Doing so, we end up with households choosing exactly one option with a probability of one in the benchmark. Given the post-reform disposable income change, we then recalculate the new utility maximising choice for each realisation of the error terms yielding a genuine probability distribution over all working-time categories.

The CGE-Module

The CGE-module is based on an applied static general equilibrium model. The general equilibrium approach allows for a quantication of direct and indirect eects arising from our policy measures. The distinctive feature of our model is the detailed modeling of the German labour market comprising sector-specic bargaining between trade unions and employers' associations. The model distinguishes between low and high-skilled labour. In each of the seven sectors, a representative rm produces a homogeneous output. Within a nested constant-elasticity-of-substitution (CES) production structure, each rm determines its optimal demand for intermediate and value added inputs. Value added inputs consist of low-skilled labour and a composite of high-skilled labour and capital, the HK-aggregate. This reects the empirical evidence that low-skilled labour is a relatively good substitute for the HKaggregate whereas capital and high-skilled labour are relatively poor substitutes for each other. In what follows, we only briey sketch the main components of the CGE model which are most relevant to our analysis. A more detailed algebraic model presentation including a description of the calibration as well as subsequent developments of the model can be found in Böhringer et al. (2005), Boeters (2005, 2006) as well as Arntz et al. (2006, 2008).

Labour Demand

Firms minimise costs at each production nest. The cost functions of the value added aggregate c va,s and the HK-aggregate c hk,s for each sector s can be written as:

c va,s = β L s w L,s • (1 + t l,s,L ) wL,s • (1 + tl,s,L ) 1-σ L s + (1 -β L s )c 1-σ L s hk,s 1 1-σ L s (3) c hk,s = β H s w H,s • (1 + t l,s,H ) wH,s • (1 + tl,s,H ) 1-σ H s + (1 -β H s ) r(1 + t k,s ) r(1 + tk,s ) 1-σ H s 1 1-σ H s ,(4)
where β L s und β H s denote initial cost shares for low-skilled labour L within the value added aggregate and for high-skilled labour H within the HK-aggregate, respectively. σ L s and σ H s are elasticities of substitution for the value added and HKaggregate. w L,s • (1 + t l,s,L ) and w H,s • (1+ t l,s,H ) represent the employer's labour costs including wage-related costs per hour for each skill type. r(1 + t k,s ) stands for the gross price of capital. Variables with a bar refer to the benchmark situation. This yields the following demand functions for low-skilled labour L L,s and high-skilled labour L H,s at the sectoral level s depending on the output level Y s :

L L,s = Y s c va,s • wL,s • (1 + tl,s,L ) w L,s • (1 + t l,s,L ) σ L s (5) L H,s = Y s c va,s c hk,s σ L s c hk,s • wH,s • (1 + tl,s,H ) w H,s • (1 + t l,s,H ) σ H s . ( 6

Wage Determination and Labour Market Equilibrium

In each sector, an employer's association and a trade union bargain over wages according to the right-to-manage approach: parties bargain over wages, and rms decide on labour demand taking the bargained wage as given (see e.g. Oswald 1985).

The bargaining outcome results from the maximisation of a Nash function Ω s that includes the objective functions of both parties and their respective fallback options.

The objective function of the employer is given by its prot π s , while the fallback option implies zero prots:

ln Ω s = ln π s + ρ H,s ln Γ H,s + ρ L,s ln Γ L,s . ( 7
)
ρ r,s denotes bargaining power of both skill types r = L, H relative to the rm's bargaining power. For each skill type, the union's objective function Γ r,s is employment L r,s times the value of a job V r,s minus the value of unemployment V U,r :

Γ r,s = L r,s (V r,s -V U,r ) . ( 8
)
Following the literature on search unemployment (e.g. Pissarides 1990), the values of the labour market states are recursively determined as weighted averages of the incomes in the case of employment and unemployment, where the weights are computed from the transition probabilities between the labour market states. [START_REF] Creedy | Discrete Hours Labour Supply Modelling: Specication, Estimation and Simulation[END_REF] More specically, the value of a job V r,s,t in period t can be expressed as:

V r,s,t = 1 1 + r I r,s (1 + npc r,s ) + (1 -µ r,s )V r,s,t+1 + µ r,s V U,r,t+1 . ( 9
)
µ r,s represents the sector-specic separation rate from employment to unemployment, npc r,s is a non-pecuniary pay component [START_REF] Duncan | Simulating Transitions Using Discrete Choice Models[END_REF] and I r,s is the average disposable income of an employed worker. Under the steady-state assumption, the value of employment equals its value in the previous period. Thus, we can replace the dierence between the value of employment and unemployment in equation ( 8) by:

V r,s -V U,r = I r,s (1 + npc r,s ) -rV U,r r + µ r,s . ( 10
) F o r P e e r R e v i e

w

The value of unemployment V U,r is assumed to be exogenously given. Trade unions take a utilitarian perspective with respect to individuals and labour supply options. In other words, an employed individual's average disposable income and the value of unemployment are calculated as weighted averages in case of employment and unemployment for all individuals and labour supply options, respectively. [START_REF]Arbeitslosengeld II reformieren: Ein zielgerichtetes Kombilohnmodell[END_REF] In turn, the wage that results from bargaining in general equilibrium is used to derive the income positions of all households in employment. To calculate disposable incomes, we use the numerically approximated values of the marginal eective tax rates (see Section 3.1.3).

A reform of the tax-transfer system has two important implications for wage determination: First, the reforms aect the eective marginal tax rates either through an explicit change in tax rates or through lower transfer withdrawal rates. Trade unions account for these skill-specic marginal tax rates in the negotiations. Apriori, the net eect is not clear because the marginal burden increases for some individuals while it decreases for others. Koskela and Vilmunen (1996) show in this context that with a constant average tax rate, an increase in the eective marginal tax rate raises the degree of tax progression, which leads to wage moderation on behalf of unions. Second, a cut in benets reduces the expected income when unemployed and, thus, the value of the fall-back position of unions. For given labour demand, this eect is further accentuated if the probability of becoming unemployed is raised due to increased labour market participation.

Outcomes of these sector-specic negotiations are the wages for low and highskilled individuals. Firms determine their optimal labour demand according to equation ( 5) and ( 6), taking the bargained wages as given. Unions anticipate rms' labour demand decisions, which inuences the outcome indirectly. The dierence between labour supply and demand endogenously determines unemployment. Individuals are mobile among sectors. In equilibrium, job-seekers must be indierent between any [START_REF]Arbeitslosengeld II reformieren: Ein zielgerichtetes Kombilohnmodell[END_REF] For couple households, the average disposable income of an employed individual is calculated as a weighted expected value, taking into account dierent labour market states "employed" (e) and "unemployed" (n) of the spouse. The disposable income for positive labour supply options is linked to the labour market status employed (e). In contrast, for individuals who are involuntarily unemployed (n) we assign the disposable income for zero hours labour supply, which is strongly determined by the German transfer system -irrespective of the actual labour supply decision. As weights for the dierent labour market states, we use the probabilities P e,j = (1 -u r ) und P n,j = u r , where u r represents the household-type specic unemployment rate. In our model, we distinguish 42 household types (see Table A1). For these categories we calibrate householdspecic unemployment rates by splitting non-working individuals into voluntarily and involuntarily unemployed persons so as to match the skill-specic unemployment rates in the benchmark.

Budget Neutrality

The scenarios are modeled as budget neutral reforms by xing the budget T in real terms according to the benchmark level. Government revenues consist of taxes on capital K s , labour, consumption C z of commodity z, output Y s and prots π s :

T = s t k,s rK s + T M S + z t c,z p c,z C z + s t y,s p y,s Y s + s t π π s , ( 11
)
where t k,s is the capital tax rate, t c,z the consumption tax rate, t y,s the output tax rate, and t π the prot tax rate. r, w i,s , p c,z and p y,s denote the respective prices. All other taxes paid by rms, e.g. trade taxes, are subsumed under the prot tax. T M S is the balance of labour income taxes plus social security contributions minus transfer payments to those households captured by the microsimulation module. The income tax contains a proportional adjustment parameter that is used for balancing the public budget in the counterfactual policy simulations. According to our comprehensive income tax, this refers to the tax rates t k,s , t π and taxes on labour that are included in T M S .

Linking the Microsimulation and CGE-Modules

The labour supply module and the CGE module are kept separate and iterated until we arrive at a global solution. [START_REF] Haan | Making Work Pay for the Elderly Unemployed: Evaluating Alternative Policy Reforms for Germany[END_REF] Using the labour supply module, we rst derive the labour supply reactions of our policy measures. Given the partial equilibrium nature of this analysis, wages and unemployment rates are held constant. The resulting labour supply is aggregated (by skill type) and transferred to the CGE model. Running the CGE model, we derive wage reactions and changes in the unemployment rate resulting from the change in labour supply. The changes in wages and income taxes required to balance the public budget are fed back to the labour supply module for the next iteration, where the next round's labour supply eects are computed. This proceeds until the two modules converge. Transferring data from the labour supply module to the CGE module requires the aggregation of individual labour supply per skill type. To do so, labour supply in hours is weighted by the respective wage rate of the benchmark yielding skill-specic labour supply in eciency units. We assume that the individual wages move in proportion to the average macroeconomic wage of the respective skill group. When transferring data from the CGE module to the labour supply module, it is therefore rst necessary to adjust individual wages and, second, to account for the change in the income tax rate, which is used to balance the government's budget in the CGE module.

Results

For both reform scenarios we rst discuss the partial equilibrium labour supply reactions, i.e. with constant wages and without imposing revenue neutrality. We then turn to the general equilibrium eects taking into account the wage responses, the labour demand reactions and the budget balancing through an adjustment of the marginal income tax.

Partial Equilibrium ALG II

Table 2 displays the transition probabilities into the dierent working hours categories conditional on status quo labour supply. When simulating labour supply eects, it has to be kept in mind that the introduction of ALG II not only directly impacts the labour supply behaviour of former beneciaries of social assistance and unemployment assistance but also entails indirect eects by generating new entitlement among those not previously eligible for benets. [START_REF] Immervoll | Welfare Reform in European Countries -A Microsimulation Analysis[END_REF] To distinguish direct and indirect eects, Panel A and B refer to those individuals who were previously entitled to benets, whereas Panel C contains the transition matrix for those not eligible in the benchmark.

The gures in the rst row of Panel A show that our model predicts slight positive participation eects for former potential SA recipients not participating in the status quo. In contrast, former SA beneciaries working 15 hours reduce labour [START_REF] Immervoll | Welfare Reform in European Countries -A Microsimulation Analysis[END_REF] A further reason for additional eligibility is the more generous wealth test under ALG II than under the SA regulations. The reform conferred entitlement to ALG II benets on people whose private assets previously excluded them by law from receiving SA and who were not eligible for unemployment assistance (see also Clauss and Schnabel 2009). market participation. Potential SA recipients who work full time and overtime in the benchmark are virtually unaected in their labour supply behaviour. This is not surprising as the optimality of such a labour supply decision reects a locally low marginal rate of substitution between consumption and leisure, thereby requiring large shifts in the budget curve in order to induce individuals to change their labour supply. Finally, a comparison of the marginal distributions of the working hours categories shows that the reform results in an overall increase in the participation rate of about 1.6 percentage points. Given the total predicted number of about 1.8 million potential SA recipients in the benchmark, [START_REF]Qualikationsspezische Arbeitslosigkeit im Jahr 2005 und die Einführung der Hartz-IV-Reform. Empirische Befunde und methodische Probleme[END_REF] this corresponds to an increase in labour supply of about 29,863 individuals in this group. Panel B reports the results for former UA beneciaries. Given our choice of working time categories this [START_REF]Qualikationsspezische Arbeitslosigkeit im Jahr 2005 und die Einführung der Hartz-IV-Reform. Empirische Befunde und methodische Probleme[END_REF] This calculation is based upon all exible individuals between 15 and 65 years in our sample. According to the ocial statistics of the Federal Statistical Oce in Germany there were 1.6 million SA employable recipients in 2004 (i.e., excluding those who were ill, disabled or in education). Therefore, our model overpredicts the number of beneciaries which is presumably mainly due to non take-up which we do not model here. group is restricted to work zero hours in the benchmark, as employed individuals working at least 15 hours were no longer eligible for unemployment assistance. A comparison of the marginal distributions of the working hours categories shows that the reform results in an overall increase in the participation rate of about 8.2 percentage points. Given the total predicted number of about 1.8 million formerly UA recipients, [START_REF] Koskela | Tax Progression is Good for Employment in Popular Models of Trade Union Behaviour[END_REF] this translates into an increase in labour supply of about 148,773 individuals in this group. Taking into account that both groups partly overlap due to some additionally participating UA recipients receiving supplementary SA (9,844 persons), this results in an overall additional labour supply of 168,792 individuals.

Panel C refers to those individuals who were neither eligible for SA nor for UA. Here we observe negative participation eects. Comparing the marginal distributions of working hours reveals that our simulations predict a reduction in participation of about 1 percentage point, corresponding to 228,354 individuals who withdraw from the labour market. The gures in the rst column reveal that the fraction of those who reduce participation is largest among those non-eligible individuals holding a part time job in the benchmark. This result may partly be attributed to the extension of eligibility to higher net earnings, which induces some individuals to reduce their labour supply in order to become entitled to supplementary benets. For couple households this creates particular incentives for women to give up a part time job thereby explaining the relatively larger participation reduction among part time working individuals. Moreover, closer inspection of the o-diagonal entries shows that formerly non-eligible individuals not only reduce participation but also working-time, which is consistent with the induced incentives to reduce labour supply.

Table 3 presents the eects on participation rates, average working time and total labour supply for a number of sub-aggregates of individuals. In row (1) we display the change in participation rates in percentage points, row (2) reports the change in average working time in per cent, whereas row (3) and ( 4) contain the change in labour supply measured in hours (3) and in persons (4).

The last column in row (1) indicates that overall participation decreases slightly by about 0.2 percentage points. Moreover, the gures show that the responses vary greatly across skill groups. In particular, the decrease in participation is more pronounced among high-skilled individuals than among their low-skilled counterparts. The reason is that the latter are disproportionately represented among former transfer beneciaries who exhibit positive participation eects. Further, women in couples feature the largest reduction in participation rates. Average working time decreases for all individual groups, giving rise to unambiguous negative eects on labour supply in hours. The overall decrease in participation translates into a reduced labour supply of about 59,563 persons, 98 per cent of which belong to the high-skilled. [START_REF] Mcfadden | Conditional Logit Analysis of Qualitative Choice Behavior[END_REF]

General Equilibrium ALG II

In this section, we turn to the general equilibrium eects following the introduction of ALG II. In addition to the labour supply eects discussed in Section 4.1, we thus account for wage and labour demand reactions as well as the adjustment of the marginal income tax rate to balance the public budget.

Table 4 shows that the reform causes low-skilled wages to decrease by 0.74 per cent, while gross hourly wages of the high-skilled slightly increase by 0.16 per cent. The fact that the reform exerts downward pressure on low-skilled wages while leaving high-skilled wages virtually unchanged can be explained by the following mechanisms. First, the reform entails an increase in the average marginal eective tax burden (row ( 8)) and a reduction in benet levels which generally leads to wage moderation on behalf of unions. Moreover, the eect on the fallback utility turns out to be larger the greater the probability of becoming unemployed. The skill-specic changes in marginal eective tax rates displayed in row (8) along with a larger status quo unemployment for the low-skilled indicate that both eects are more relevant for this skill group. In sum, this induces a larger downward pressure on low-skilled wages. Second, there is a countervailing eect on wages since a decrease in labour market participation tends to reduce unemployment rates and, therefore, raises fallback utilities and wages. For high-skilled individuals this countervailing eect on wages dominates and even causes wages even to increase somewhat, as the decrease in participation is relatively more pronounced among this skill group. With respect to the general equilibrium labour supply responses, the gures in row ( 1) and ( 4) indicate negative participation eects which are of a similar magnitude but slightly larger than those in Table 3. The reinforcing negative eect on participation is more pronounced among the low-skilled due to the reform's negative impact on low-skilled wages. Further, the wage reduction for the low-skilled translates into an increase in labour demand by 0.34 per cent, as measured by the increase in hours of employment (row( 5)). For the high-skilled, in contrast, labour demand in hours is reduced by 0.17 per cent. Despite this decrease, the employment response at the extensive margin is found to be positive for both groups (rows ( 6) and ( 7)), which is due to the reduction in working time among those participating in the labour market (row (2)). Along with the decrease in participation this translates into a 1.22 percentage point reduction of the unemployment rate for the low-skilled and a 0.45 percentage point reduction for the high-skilled (row ( 9)). While the participation rate of former SA beneciaries is raised by 4.7 percentage points, the increase amounts to 12.9 percentage points for former UA beneciaries. Due to the stronger benet reduction and the more generous transfer withdrawal regulations the positive participation eects are therefore much larger than in the ALG II scenario. A comparison of Panel C in Table 2 and 5 shows that the decrease in participation among non-eligible individuals is of a similar magnitude as that following the introduction of ALG II. Overall, the increase in participation among former beneciaries corresponds to an additional labour supply of 269,911 persons, while the decrease among formerly non-eligible individuals results in 211,711 individuals withdrawing from the labour market.

Partial Equilibrium Modied ALG II

The last column in row (1) in Table 6 shows that the overall increase in participation is about 0.2 percentage points. Among the displayed subaggregates, the only individual group featuring a decrease in participation is that of women in couple households. This result is driven by women who react to the increased labour supply of formerly non-working spouses by reducing own labour market participation. Moreover, the gures show that, similar to the introduction of ALG II, positive participation reactions are typically stronger among low-skilled individuals as compared to their high-skilled counterparts. Average working time is found to decrease for all individual groups. Compared with the introduction of ALG II the decrease is even more pronounced as part time employment becomes considerably more attractive due to the more generous transfer withdrawal regulations. The last column in row (3) shows that the reduction in average working time results in a negative labour supply reaction along the intensive margin, i.e. labour supply measured in hours decreases even though the labour supply reaction along the extensive margin is found to be positive.

General Equilibrium Modied ALG II

Turning to the general equilibrium eects, the gures in row (6) in Table 7 show that the reform exerts downward pressure on both low and high-skilled wages, which are predicted to decrease by 1.7 per cent and 0.4 per cent, respectively. Underlying these relatively larger wage reductions compared with the ALG II scenario are the following mechanisms. A rst explanation is that our second scenario entails a more pronounced increase in the average marginal tax burden of 3.8 percentage points for the low-skilled and 2.1 percentage points for the high-skilled (row ( 8)), respectively. A second reason is that, due to the larger reduction in benet levels, the modied ALG II leads to a considerably larger reduction in the fallback utility of unions. The gures in row (1) and ( 4) show that compared with the partial equilibrium results in general equilibrium the positive participation responses are mitigated for both skill groups, giving rise to an overall increase in labour supply of 20,189 persons. The wage reductions for both skill groups lead to an increase in labour demand. From row (5) it can be seen that the increase in hours of employment turns out to be more procounced for the low-skilled due to their larger wage reduction and their larger labour demand elasticities. Owing to the reduction in working time, the employment response at the extensive margin is again found to be larger for both skill groups (rows ( 6) and ( 7)). Along with the decrease in labour supply, the gures in row (9) show that unemployment rates decrease for both skill groups. The increase in employment at the extensive margin results in 58,208 low-skilled and 131,597 highskilled individuals who are additionally employed after the reform. Note that the employment gain of high-skilled individuals exceeds that of low-skilled individuals in absolute terms as high-skilled labour represents a considerably larger fraction of our relevant population. In sum, the overall employment gain of 189,806 persons is found to be considerably larger than in the ALG II scenario. Taken together, when comparing our general equilibrium analysis with the partial equilibrium results, our simulations suggest that the employment eects of any reform are likely to be considerably understated unless potential wage adjustments and the resulting changes in unemployment rates are accounted for. coexisting transfer systems of social assistance and unemployment assistance into one unied benet (Arbeitslosengeld II -ALG II). Given that the introduction of this unied benet left the labour supply disincentives of the German welfare system to a large part unchanged, we also consider a second reform scenario that is intended to further encourage labour market participation of low-skilled workers.

Our methodological contribution is to use an integrated CGE-microsimulation model. In adopting such an approach, we are able to combine the advantages of microsimulation studies by accounting for the large amount of heterogeneity in terms of households' preferences and budget constraints with the advantages of an applied general equilibrium model. The latter permits us to identify potential general equilibrium repercussions through changes in wages and unemployment. Such feedback eects are especially relevant in our case, since the reforms considered here aect a large number of individuals directly and a considerable number of individuals indirectly, by generating additional entitlement to benets.

Overall, our simulations lead us to conclude that the Hartz IV reform is unlikely to succeed in producing substantial labour supply and employment eects. In particular, the results of the partial equilibrium analysis show that potential positive participation eects of former transfer beneciaries are likely to be dominated by negative participation eects of formerly non-eligible individuals. In sum, our simulations predict a decrease in labour supply of about 60,000 persons. The general equilibrium results indicate that due to the larger average marginal tax burden and the lower benet level low-skilled wages decrease, whereas high-skilled wages are virtually left unchanged. Along with the decrease in participation this leads to lower unemployment rates and to an overall employment gain of about 45,000 individuals.

In contrast, the simulation results of our modied reform scenario indicate that a cut in benet levels combined with a reduction in transfer withdrawal rates may entail considerably larger labour supply and employment eects. Yet, given that there are about 3.2 million households ("Bedarfsgemeinschaften") who are likely to be aected by the reform, the overall magnitude of the predicted employment gain of about 190,000 persons still appears to be rather modest. Similar to the introduction of ALG II, the simulations show that the comparatively modest employment gain is mainly driven by formerly non-eligible individuals. By generating additional entitlement, the reforms induce women in couples in particular to withdraw from the labour market in order to become eligible for supplementary benets.

When comparing our general equilibrium analysis with the partial equilibrium microsimulation results, our simulations suggest that the employment eects of any reform are likely to be considerably understated unless potential wage adjustments and the resulting changes in unemployment rates are accounted for. Our results consequently strongly suggest the need for a model capable of simulating labour supply eects and accounting for changes in wages and unemployment in order to obtain an ex-ante assessment of the associated employment eects.

A.2 Calculation of Disposable Incomes

To calculate disposable incomes, we account for the following tax and transfer components:

Social security contributions: From gross earnings, we deduct contributions to the unemployment, health and pension insurance up to the upper social security contribution limit. For health insurance contributions, we assume the average contribution rate. Gross monthly earnings below 400 e are exempted from social security contributions, while gross earnings between 400 and 800 e are subject to a reduced contribution rate.

Income taxes: Income taxes are calculated on the basis of taxable income which is obtained by subtracting standard deductions from gross earnings. To determine income taxes we apply the 2004 German tax schedule to taxable earnings. For married couples, income tax legislation allows for marital income tax splitting.

According to this method, the tax schedule is applied to half of the joint taxable income, while the resulting tax amount is doubled to obtain total income taxes.

Housing benets: Because social assistance and ALG II already contain a housing transfer component, households who are entitled to these transfers are not eligible for housing benets. For the remaining households we calculate the entitlement to housing benets on the basis of rents and household income. Child benets: We consider child benets which are 154 e for each child (from the fourth child onwards the benet amounts to 179 e). For those households who fare better with a child exemption we consider the latter to compute taxable earnings.

Apart from these tax and transfer components we account for further transfer and income components, such as e.g. alimonies, student transfers (BAföG), scholarships, maternity leave transfers, pensions as well as incomes from community or military services. The latter ve components are only relevant for individuals with a xed labour supply and are considered to compute the total disposable income in mixed households.

Household wealth: As our data contain only insucient information on assets, we use information on the yearly interest incomes together with incomes from dividends to compute potential capital assets. These calculated assets serve as a basis for the wealth test. Its innovative feature is the incorporation of decentralised wage bargaining, which is modelled as a "right-to-manage" Nash-bargaining, as presented in Section 3.2.2 in the main text.

A.3 Estimation Results

Firms

In each production sector, a representative firm produces a homogeneous output. We use a nested constant-elasticity-of-substitution (CES) production function to reflect empirical evidence on the substitution possibilities. Figure 1 provides a diagrammatic overview of the nesting structure.

K s = Y s c va,s c hk,s σ L s c hk,s r(1 + tk ) r(1 + t k ) σ H s .
Capital and labour are mobile across sectors. The market for capital is perfectly competitive. In our central model variant, we assume that capital is internationally immobile, which reflects a short-to medium-run model horizon.

Each individual firm is assumed to be small in relation to its respective sector. All firms in one sector interact through monopolistic competition, i.e. they produce individual variants of the sectoral output good Y s , which attract different consumers. This means that firms can exploit market power in their respective market segment. Producer output prices then consist of costs plus a fixed mark-up. The budget constraint of the representative firm reads

(1 -m s )p y,s Y s = ss p a,ss A ss,s + r(1 + t k )K s + i w i,s (1 + t l,i )L i,s , (1)
where m s := price mark-up rate, p y,s := output price, A ss,s := intermediary input from Armington good ss, p a,s := price of Armington good s, L i,s := labour input of skill type i.

Profits in sector s are given by π s = m s p y,s Y s .

(2)

Private Households

The household sector is differentiated into three representative households, two worker households and one capitalist household. One representative worker household captures the individual households with flexible labour supply that are part of the microsimulation module. The second representative worker household includes all households that are not part of the microsimulation module because their labour supply is assumed to be fixed. The third household is endowed with capital and property rights of the firms. It is also subject to a lump-sum tax or a transfer to balance the government's budget. Only the capitalist household takes a consumption-savings decision. The representation of this decision follows the approach of Ballard et al. (1985), where the savings function is sensitive to both the real interest rate and the price of investment goods. The households savings then correspond to the purchase of a uniform investment good at price P I per unit. This investment good is a fixed-coefficient composite of all Armington goods (see Section 1.3). The households derives its utility from the future stream of consumption that corresponds to the return to investment. In formal terms, the household's trade-off between current Q and future consumption C F on the top level of its decision problem is

max U (Q, C F ) s.t. P Q Q + P S C F = I e , (3)
where

P Q := price of Q, P S := price of C F , I e := extended income, see (8).
To determine P S , it is assumed that each unit of investment (savings), S, generates a stream of φ units of capital services in each future period (where φ is a constant determined by the steady state condition). These services yield yearly income at rate r (net of taxes), which is then traded for the consumption goods composite at rate P C (note that P C is not differentiated across households, because all households are assumed to have the same consumption spending pattern). Together with the price P I of the investment good, which is defined as Leontief aggregate over Armington goods, we then obtain:

P S = P I P C φr . (4)
In calibrated share form, U reads as

U =   θ Q Q Q 1-σ s i σ s i + 1 -θ Q S S 1-σ s i σ s i   σ s i 1-σ s i , (5)
with θ Q denoting the value share of current consumption in extended income. The associated unit expenditure function is

P U = θ Q P Q PQ 1-σ s i + 1 -θ Q P S PS 1-σ s i 1 1-σ s i . ( 6
The assumption of a flexible savings price drives a wedge between the amount of money actually spent on investment goods and the savings term appearing in the utility maximising problem, because P S generally does not equal P I . In order to assure that the household's budget constraint actually holds, we must correct for the difference between P S and P I . Extended income I e then becomes

I e,i = r K + Π + (P S -P I )S -T LS , (8)
where K := aggregated capital stock, Π := aggregated profits, T LS := lump-sum tax or benefit.

We assume identical consumption spending patterns for all three aggregate households. Aggregate consumption, C, which is is equal to the sum of the consumption of the three household types, is distributed among the different consumption goods, C z , according to a CES function:

P C PC = z θ C z p c,z (1 + t c,z ) pc,z (1 + tc,z ) 1-σ c 1 1-σ c , ( 9
)
C z Cz = C C P C PC pz,c p z,c σ c , (10)
where Following the small open economy assumption, export and import prices in foreign currency are not affected by the behaviour of the domestic economy. In other words, the small open economy faces infinitely elastic world export demand and world import supply functions.

P C := consumer price index, θ C z := benchmark
Analogously to the export side, we adopt the Armington assumption of product heterogeneity for the import side. A CES function characterises the choice between imported and domestically produced varieties of the same good:

A s = z A s,z + G s + I s + t A s,t , (16)
where

A
σ m s . ( 18
)
The flexible exchange rate, x, adjusts so as to leave the benchmark balance of payments deficit (or surplus), BOP , unchanged in terms of world market prices.

Data and Parameterisation

The remainder of this appendix lays out the parameterisation of our model:

-Cost shares of production factors and mark-up rates: Our main data source is the 2002 input-output Office of Germany, which contains a consistent data set of economic transactions for 71 sectors. The German IOT provides a decomposition of total value-added into remuneration of capital and labour. We disaggregate the respective values into capital services and profits on the one hand, and labour incomes of the two skill groups on the other. To quantify profits, we use the German Federal Bank's (Bundesbank, 2006) publication on annual accounts of West-German enterprises. We take the profit per Euro of sales ratio (before tax) to measure profits. Expenses for capital services are calculated as the difference between total capital earnings and profits. Mark-up rates result as the ratio of profits over sales. To divide the total amount of labour earnings per sector into income of high-skilled and low-skilled workers, we employ data from the employment statistics register (Beschäftigtenstatistik). This database covers all employees holding a regular job, i.e. those who have to pay social security contributions. An employee without a vocational or academic degree is treated as "unskilled". -Elasticity of substitution in production: Falk and Koebel (1997) provide estimates for five aggregated sectors. Complementary information on factor price elasticities are taken from Buslei and Steiner (1999). -Calibration of the elasticities of substitution between current and future consumption σ s : σ s can be inferred from empirical estimates of the uncompensated elasticity of savings with respect to the interest rate, ψ. Using the demand equations of Section 1.2, the following relationship applies (index i has been dropped): ψ = σ s θ H + rK I e , where θ H is the value share of savings and current utility. We set the elasticity of savings with respect to the interest rate equal to 0.4 (see Bernheim 2001).

-Income tax rate: We model a dual income tax, which treats incomes from different sources differently. To determine the average tax burden on capital, we sum up the revenue of the interest tax and the non-assessed income tax and add a small part of the assessed income tax according to information given by federal authorities (BMF, 2002). -Profit tax rate: All other taxes levied on companies are treated as a profit tax. They include the corporate tax and parts of personal income taxation. We derive the tax rates applied at the aggregate level from the tax revenue statistics of the Federal Ministry of Finance (BMF, 2002). -Separation rates: These are computed from the IAB-Employee sample (IABS), which is a two per cent sample of the complete employment statistics register data. They are defined as outflows into unemployment (defined as outflows into transfer receipt) within one year over the number of employees in the middle of the same year. For the numerical simulations, we take a 5-year average (1997-2001). -Armington elasticities: These are taken from Welsch (2001). They range between 0 and 2. Services and the construction sector are treated as nontradables. -The elasticity of transformation between domestically supplied and exported goods: It is uniformly set to 2.

3. 1

 1 Microsimulation Model 3.1.1 Data and Household Types

2

 2 Discrete Choice Model of Labour Supply

16

 16

22

 22

Figure 1 : 1 Page

 11 Figure 1: Nesting structure of production function

  share of domestic consumption in domestic production, θ Ex s := value share of exports, p d,s := price of D s , p Ex,s := export prices, η := elasticity of transformation, x := foreign exchange rate.

  share of domestic production in domestic consumption, θ AM s := value share of imports, Im s := Imports, σ Im s := elasticity of substitution, p a,s := price of Armington good, p Im,s := import prices (fixed in foreign currency). The Armington good enters intermediate and final demand. The associated market clearing condition is

Table 1 :

 1 Wage-assistance dierentials SA and ALG IIThe minimum income level consists of the basic rates, additional needs as well as average rent and heating costs. The calculation of disposable income is performed on the basis of a gross hourly wage of 8.50 e, a 38 hours full time job held by the head of the household and accounts for housing and child benets. SOEP 2004, own calculations.

	To illustrate the

Page 9 of 43 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

					Submitted Manuscript
		Figure 1: Disposable Income of a Single Person with no Children
	Disposable Household Income	0 300 600 900 1200	o r F o r
			0	200	P e e r 400 600 800 1000 1200 1400 1600 1800 2000 P Gross Monthly Earnings in Euro UA Status quo e ALG II Modified ALG II e r
	Disposable Household Income	300 600 900 1200				R e v i e w R e v i e w
		0
			0	200	400	600	800 1000 1200 1400 1600 1800 2000
						Gross Monthly Earnings in Euro
						SA Status Quo	ALG II
						Modified ALG II
						7

Table 2 :

 2 Transitions into working hours categories ALG II

	Status quo (SQ)				Scenario
	A. SA				ALG II
	beneciaries	0	15	30	38	47	Distribution SQ
	0	97.5	0.7	0.4	1.3	0.1	69.1
	15	0.6 98.4	0.5	0.5	0.0	13.3
	30	0.0	0.0 99.6	0.3	0.0	6.9
	38	0.0	0.0	0.0 99.9	0.1	4.3
	47	0.0	0.0	0.0	0.0 100	6.4
	Distribution ALG II	67.5 13.5	7.2	5.3	6.5	100.0
	B. UA				ALG II
	beneciaries	0	15	30	38	47	Distribution SQ
	0	91.8	2.3	0.9	4.2	0.8	100.0
	Distribution ALG II	91.8	2.3	0.9	4.2	0.8	100.0
	C. Non-eligible				ALG II
	individuals	0	15	30	38	47	Distribution SQ
	0	99.4	0.4	0.1	0.1	0.0	16.3
	15	2.1 97.6	0.1	0.2	0.0	12.0
	30	2.1	0.6 97.2	0.1	0.0	9.2
	38	1.0	0.6	0.1 98.2	0.0	50.2
	47	0.5	0.6	0.1	0.3 98.5	12.3
	Distribution ALG II	17.3 12.2	9.0 49.4 12.1	100.0
	Transition probabilities (per cent) into dierent working hours categories conditional on status quo labour supply choice.

Table 3 :

 3 Labour supply eects ALG II

		Couples	Singles Qualication	All
	Change	Men Women	Low	High
	(1) Participation rate (in %-points)	0.084	-0.467 -0.209 -0.029 -0.248 -0.215
	(2) Average working time (in per cent) -0.292	-0.247 -0.626 -0.606 -0.302 -0.339
	(3) Labour supply in hours (in per cent) -0.208	-0.975 -0.892 -0.652 -0.616 -0.620
	(4) Labour supply in persons			-1,204 -58,359 -59,563

Table 4 :

 4 General equilibrium labour supply and employment eects ALG II

		Couples	Singles Qualication	All
	Change	Men Women	Low	High
	(1) Participation rate (in %-points)	0.024 -0.540 -0.263 -0.199 -0.292 -0.278
	(2) Average working time (in per cent)	-0.312 -0.298 -0.682 -0.693 -0.333 -0.375
	(3) Labour supply in hours (in per cent)	-0.294 -1.141 -1.015 -1.014 -0.703 -0.738
	(4) Labour supply (in persons)		-8,396 -68,688 -77,084
	(5) Employment (hours, in per cent)		0.337 -0.173 -0.130
	(6) Employment (persons, in per cent)		1.229	0.114	0.233
	(7) Employment (in persons)		25,111 19,556 44,667
	(8) Gross wages (in per cent)		-0.740	0.155
	(9) Unemployment rate (in %-points)		-1.219 -0.447
	(10) Av. eective marginal tax rate (%-points)		2.878	1.364

Table 5

 5 displays the transition probabilities into the dierent working hours categories for the modied ALG II scenario (M-ALG II). When interpreting the gures, it is helpful to place the results in Table5alongside the gures in Table2. In partic-

21 Page 23 of 43 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

  ular, a comparison of Panel A and B in Table2and 5 shows that the dierences in the participation eects are mainly driven by the labour supply responses of former potential transfer recipients.

	Submitted Manuscript
	F o r
	P
	e
	e r
	R
	e
	v i e
	w

Table 5 :

 5 Transitions into working hours categories M-ALG II

	Status quo (SQ)				Scenario
	A. SA				M-ALG II
	beneciaries	0	15	30	38	47	Distribution SQ
	0	92.8	1.5	1.3	3.9	0.5	69.1
	15	2.1 93.9	1.2	2.3	0.6	13.3
	30	0.0	0.0 99.7	0.3	0.0	6.9
	38	0.1	0.1	0.1 99.7	0.1	4.3
	47	0.0	0.0	0.0	0.2 99.7	6.4
	Distribution ALG II	64.4 13.5	8.0	7.3	6.8	100.0
	B. UA				M-ALG II
	beneciaries	0	15	30	38	47	Distribution SQ
	0	87.1	3.5	1.5	6.6	1.3	100.0
	Distribution M-ALG II	87.1	3.5	1.5	6.6	1.3	100.0
	C. Non-eligible				M-ALG II
	individuals	0	15	30	38	47	Distribution SQ
	0	99.3	0.3	0.2	0.2	0.0	16.3
	15	2.1 97.5	0.2	0.2	0.0	12.0
	30	1.9	0.8 97.1	0.2	0.0	9.2
	38	1.0	0.9	0.1 97.9	0.0	50.2
	47	0.5	0.7	0.1	0.9 97.8	12.3
	Distribution M-ALG II	17.2 12.3	9.1 49.4 12.0	100.0
	Transition probabilities (per cent) into dierent working hours categories conditional on status quo labour supply choice.

Table 6 :

 6 Labour supply eects M-ALG II

		Couples	Singles Qualication	All
	Change	Men Women	Low	High
	(1) Participation rate (in %-points)	0.183	-0.289	0.919 0.609 0.138 0.210
	(2) Average working time (in per cent) -0.510	-0.283 -0.839 -0.609 -0.481 -0.503
	(3) Labour supply in hours (in per cent) -0.311	-0.734	0.326 0.374 -0.307 -0.229
	(4) Labour supply in persons			25,718 32,482 58,200

Table 7 :

 7 General equilibrium labour supply and employment eects M-ALG II

		Couples	Singles Qualication	All
	Change	Men Women	Low	High
	(1) Participation rate (in %-points)	0.054 -0.415 0.758 0.297	0.032	0.073
	(2) Average working time (in per cent)	-0.572 -0.391 -0.936 -0.804 -0.552 -0.584
	(3) Labour supply in hours (in per cent)	-0.516 -1.039 0.024 -0.325 -0.511 -0.489
	(4) Labour supply (in persons)		12,559	7,630 20,189
	(5) Employment (hours, in per cent)		1.056	0.044	0.129
	(6) Employment (persons, in per cent)		2.824	0.768	0.989
	(7) Employment (in persons)		58,208 131,597 189,806
	(8) Gross wages (in per cent)		-1.680 -0.389
	(9) Unemployment rate (in %-points)		-1.856 -0.671
	(10) Av. eective marginal tax rate (%-points)		3.848	2.076
	5 Conclusions
	The purpose of the present paper was to quantify the employment eects of the
	recent German welfare reform. The key element of this reform was to merge the
	24

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

Table A1 :

 A1 Household categories

	Number Denition
	16	Flexible couple, skill group wife i and husband j, x children
	8	Husband in mixed couple, skill group i, x children
	8	Wife in mixed couple, skill group i, x children
	2	Single male, skill group i, no children
	2	Single female, skill group i, no children
	6	Single, skill group i, x children
	i, j = L (low-skilled), H (high-skilled), x = 0, 1, 2, 3 (or more) children.
	Low-skilled individuals are those without any completed vocational training.

Table A2 :

 A2 Maximum Likelihood Estimation Results Single Men

	F o r
	P
	e
	e r
	Coe. 10.11 0.06 R Disposable Income X Leisure Disposable Income Disposable Income^2 -2.41 Leisure 74.05 21.47 SE 2.71 0.04 0.59 -4.10 z 3.73 1.37 3.45 e Leisure^2 -6.80 2.51 -2.70 Leisure X High-skilled 1.77 2.16 0.82 Leisure X Low-skilled 2.36 2.21 1.07 Leisure X East 0.49 0.37 1.30 v i e Leisure X ationality 0.75 0.85 0.88 Leisure X Age -0.80 0.47 -1.71 w	P>z 0.00 0.17 0.00 0.00 0.01 0.41 0.29 0.19 0.38 0.09
	Leisure X Age^2	0.00	0.00	0.82	0.41
	Leisure^2 X Age	0.09	0.06	1.64	0.10
	Leisure X Disabled	0.95	0.88	1.07	0.28
	Dummy Full time Employment	3.91	0.27 14.64	0.00
	Observations		3,000
	Log Likelihood		-669
	Conditional Multinomial Logit with 5 working hours categories.
	(0, 15, 30, 38, 49). SOEP 2004.

Table A3 :

 A3 Maximum Likelihood Estimation Results Single Women

		Coe. SE	z	P>z
	Disposable Income Disposable Income^2 Disposable Income X Leisure Leisure Leisure^X 2 F o r	8.27 0.26 -2.36 87.75 19.86 2.82 0.07 0.58 -4.08 0.00 2.93 0.00 3.90 0.00 4.42 0.00 -8.99 2.37 -3.79 0.00
	Leisure X High-skilled Leisure X Low-skilled Leisure X East P Leisure X Nationality e Leisure X Age Leisure X Age^2 Leisure^2 X Age e r	1.79 2.67 -0.25 1.63 0.38 0.00 -0.07	1.31 1.37 0.38 -0.65 0.51 1.36 0.17 1.95 0.05 0.61 2.65 0.01 0.44 0.86 0.39 0.00 2.14 0.03 0.06 -1.20 0.23
	Leisure X Disabled Leisure X Children < 7 Leisure X Children 7-16 Leisure X Children >=17 R e -0.25 4.13 1.08 0.57	1.40 -0.18 0.86 0.55 7.47 0.00 0.25 4.33 0.00 0.31 1.85 0.06
	Dummy Full time Employment Dummy Part time * ) Employment Observations Log Likelihood	0.02 -1.66 v i 0.38 0.28 -5.86 0.00 0.07 0.95 3,890 -974 e
	Conditional Multinomial Logit with 5 working hours categories (0, 15, 30, 38, 49). SOEP 2004. w
	* ) 15 or 30 hours per week

Table A5 :

 A5 Maximum Likelihood Estimation Results Mixed Couples

	Separate Appendix for Referees:
	Description of the CGE Model
	1 Equations and Variables of the Model
			Coe.	SE	z P>z
	Disposable Income PACE-L is a static general equilibrium model for an open economy covering 7 sectors. 1.94 1.61 1.20 0.23
	Disposable Income^2		0.46	0.07	6.92 0.00
	Disposable Income X Leisure		-1.39	0.35 -4.00 0.00
	Leisure		66.75 21.64	3.08 0.00
	Leisure X Household Head Female Leisure^2 Leisure X Leisure inex. Spouse Leisure X High-skilled X Female Leisure X Low-skilled X Female F o r	0.09 -5.37 -0.13 0.71 1.73	0.75 2.66 -2.02 0.04 0.11 0.91 0.16 -0.79 0.43 1.15 0.62 0.54 1.23 1.41 0.16
	Leisure X High-skilled X Male Leisure X Low-skilled X Male Leisure X Age P Leisure X Age^2 e Leisure^2 X Age Leisure X East Leisure X East X Household Head Female e r	-0.79 -1.42 -0.76 0.01 0.04 1.60 -3.47	1.20 -0.66 0.51 1.29 -1.10 0.27 0.46 -1.67 0.09 0.00 3.56 0.00 0.05 0.77 0.44 0.65 2.48 0.01 0.71 -4.87 0.00
	Leisure X Nationality Leisure X Children < 7 years Leisure X Children 7-16 years Leisure X Children >=17 years	R e	-1.49 1.27 0.93 0.49	0.56 -2.65 0.01 0.69 1.85 0.06 0.27 3.43 0.00 0.21 2.29 0.02
	Leisure X Male X Disabled Dummy Part time * ) Employment Wife Dummy Full time Employment Wife Dummy Full time Employment Husband v 0.66 -0.24 0.69 3.76 i e	1.14 0.22 -1.12 0.27 0.58 0.56 0.34 2.06 0.04 0.37 10.29 0.00
	Dummy Employment X Children < 7 years Dummy Employment X Children 7-16 years Observations	-0.41 0.21 w 0.40 -1.04 0.30 0.16 1.32 0.19 4,745
	Log Likelihood			-1,215
	Conditional Multinomial Logit with 5 working hours categories
	(0, 15, 30, 38, 49). SOEP 2004.
	* ) 15 or 30 hours per week.

  Domestically produced goods are converted through a constant elasticity of transformation (CET) function into specific goods, D s , destined for the domestic market and goods, Ex s , destined for the export market:

	1.3 Foreign Trade
		Y s Ȳs	= θ Y D s	D s Ds	1+η η	+ θ Ex s	Ex s Ex s	1+η η	η 1+η	,	(12)
	with an associated price equation
		F r o p y,s (1 + t y,s ) py,s (1 + ty,s ) = θ Y D s	p d,s pd,s	1+η	+ θ Ex s	x • p Ex,s x • pEx,s
			P
			e
			e r
					R
					e
							v i e
			value share of consumption good z, w
	p c,z := producer price of consumption good z,
	t c,z := consumption tax,
	σ c	:= elasticity of substitution in consumption.
	Each consumption good, C z , is composed of the Armington goods, A s,z , (see Section
	1.3) in fixed proportions:		A s,z Ās,z	=	C z Cz	.		(11)

  s,z := derived Armington demand from private consumption, G s := government consumption, I s := investment demand, A s,ss := intermediate demand from sector ss.The market clearing condition for the domestically produced good destined for the home market is

			Y s Ȳs	p y,s (1 + t y,s ) py,s (1 + ty,s )	pd,s p d,s	-η	=	A Ā	p a,s pa,s	pd,s p d,s	σ m s	.	(17)
	Foreign closure of the model is warranted through the balance of payments con-
	straint:
	BOP +	s	Ex s	Y s Ȳs	p y,s (1 + t y,s ) py,s (1 + ty,s ) x x	-η	=	s	Ms	A Ā	p a pa	x(1 + tm,s ) x(1 + t m,s )

The precise legal denition of "employability" requires persons being capable of working at least three hours a day.

For more details on the wealth test, see e.g.[START_REF] Arntz | Arbeitsangebotseekte und Verteilungswirkungen der Hartz-IV-Reform[END_REF].

For example, in 2004 around 30 per cent of all UA and SA recipients had no formal vocational qualications. Source: Own calculations SOEP 2004.

For the threshold in the low-wage sector, we assume a gross hourly wage of 2/3 of the median of the wage distribution. This corresponds to an hourly wage of 8.50 e.

Later on, in the simulations, one-time payments are accounted for by adding a constant rate of 18 per cent to the basic social assistance rates.

The calculation of the standard rate assumes a monthly gross rent of 216 e. Further, in the gure one-time payments are accounted for by adding a constant rate of 18 per cent to the basic social assistance rate.

These include, for example, single parents, households with children younger than 14 years and individuals with a reduced earning capacity.

For singles without children (with children), the reduced transfer withdrawal rate applies up to a threshold of 800 e (1,000 e). Gross labour earnings exceeding this amount are taxed away at a rate of 90 per cent up to an amount of 1,600 (1,800) e. For couples without children (with children), we impose a similar reduction in transfer withdrawal up to a threshold of 1,200 e (1,600 e). Labour earnings in excess of this amount are taxed away at a rate of 90 per cent rate up to earnings of 1,600 (2,000) e

In what follows, hours categories and hours-combination categories are used synonymously.

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript

The transition probabilities from employment to unemployment result from the sector-specic separation rates and sectoral unemployment rates. While the separation rates are obtained from the IABS-Employment Subsample, the latter are calibrated within the model.

Given the initial wage dierentials, the non-pecuniary components are calibrated so as to render unemployed individuals indierent between employment in the dierent sectors.

Page 16 of 43 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript

In the literature, this procedure is usually referred to as an iterative "bottom-up-top-down" approach (for a taxonomy see e.g.[START_REF] Peichl | The Benets of Linking CGE and Microsimulation Models: Evidence from a Flat Tax Analysis[END_REF]).

The convergence criterion is the change in the unemployment rates: if the change in unemployment rates between two subsequent iterations of less than 10e-5, the solution is found.

This calculation is based upon all exible individuals between 15 and 65 years in our sample. According to the ocial statistics of the Employment Agency (BA) in Germany there were 2.26 million UA recipients in

Using the same microsimulation model,Clauss and Schnabel (2008) obtain a reduction in labour supply of about -12,000 persons. The dierent results can be traced back to their simulation method. While our simulations are based upon calibrated transition probabilities,Clauss and Schnabel (2008) use the predicted choice probabilities of the conditional logit model.