The Effect of the Size of Child Allowances on the Labor Supply
- The government sharply reduced child allowances in the beginning of the previous decade.
- The reduction of the child allowances increased the labor supply of families with numerous children compared to families with fewer children. The main impact was on adults with low education levels.
- The research did not find a significant impact of the reduced allowances on other population groups.
How do government allowances impact on the labor supply? This question has considerable importance in light of the major changes made by the government in the size and composition of the allowances in recent years. In research published by the Bank of Israel today, Dr. Yuval Mazar of the Bank’s Research Department and Dr. Yaniv Reingewertz from Haifa University analyzed this question by means of an examination of the impact of the child allowance reduction in Israel from 2003 (Figure 1) on the labor force participation rate, which is an indicator of labor supply.
Figures 2.a and 2.b depict the development of the participation rate of women and men over time. The figures seem to indicate that the change in allowances in the beginning of the previous decade led to a more marked increase in the participation rate of families with four or five children (families with numerous children) compared to those with two or three children (families with fewer children).
The research uses a difference in differences method and the personal characteristics of employees to estimate the changes in labor supply of women and men with numerous children compared to changes in the labor supply of women and men with fewer children, excluding as much as possible the potential effects of other factors. It was found that the reduction of the allowances led to a marked increase in the labor supply of families with numerous children: an increase of approximately 3.6 percentage points in the participation rate of women and approximately 2.6 percentage points in the participation rate of men, relative to women and men with fewer children (Tables 1 and 2). It was also found that the main impact was on families with numerous children in weaker localities, and particularly for women or men with lower education levels. These are the groups for whom the allowance reduction decreased income by the greatest share. In contrast, no effect of the child allowance reduction was found on the participation rate among the ultra-Orthodox and the Arab women populations (Table 3).
The elasticities of labor supply that were found for families with numerous children in Israel are high compared with various groups examined in the international literature. Although the research confirms the commonly held assumption that the policy of reducing child allowances had a positive effect on labor supply, the research also indicates that it impacted particularly on the population groups noted above, and almost not at all on other population groups.
The ramification for policy formulation that arises from the findings is that when making large changes in transfer payments, account should be taken of their impact on incentives to work. In particular, programs that condition financial assistance to working age families on employment, such as the earned income tax credit, create better balance between the incentives to work and the reduction of poverty than do child allowances, which are not conditioned on employment.