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This paper empirically analyzes the labor supply effects of two “making work pay” reforms in Germany. We provide evidence in favor of policies that distinguish between low effort and low productivity by targeting individuals with low wages rather than those with low earnings. We discuss our results more generally and with comparisons to the family-based tax credits in force in the US and the UK. For the evaluation of the policies, we apply a static structural labor supply framework and explicitly account for demand-side constraints by using a double-hurdle model. [ABSTRACT FROM AUTHOR]

The "big trade-off," described by Arthur Okun some thirty years ago, is back again: equality or efficiency, or to put it differently, modern highly developed economies and societies have to choose between the Scylla of income inequality and the Charybdis of unemployment. Furthermore, it looks like the continental European economies—foremost Germany and France—sided with more egalitarian ends accepting higher unemployment while the liberal economies such as the United States and the United Kingdom chose higher inequality for lower unemployment. In this paper it is argued that the trade-off is not a supply-side necessity to maintain work effort in a situation of incomplete contracts, but is a politico-economic issue of particular interest groups seeking rents. However, unlike in Mancur Olson's seminal approach, it is not the trade unions that are forming distributional coalitions on the labor market, but rather the meritocracy which is happy to use Keynesian-type demand management to advance their material interests by pursuing a "meritocratically optimal rate of unemployment" (MORU). [ABSTRACT FROM AUTHOR]