Conditional Earnings Subsidies for Low Earners

In order to be eligible for in-work tax credits, it is often not enough to have low earnings. In Ireland, New Zeand the United Kingdom, for example, for eligibility, it is also required that the number of hours worked is sufficiently high. Similarly, in Belgium and France, the hourly wage rate must be sufficiently low. In this paper, I provide a justification for such additional conditions. I analyze Pareto-efficient redistribution from high to low ability individuals in a model where labor has several intensive margins. Besides labor hours, labor effort – a vector of unpleasant, but productive features of labor – is also an object of choice. Effort and ability determine the hourly wage rate. I find that conditional subsidies on earnings for low earners are optimal: the earnings of low earners should be subsidized at the margin, but only if they earn more by working more hours at a sufficiently low wage rate.