Optimal Tax Credits in the Context of the German System of Apprenticeship Training and Social Security

There is an ongoing discussion in Germany about the implementation of tax credits in order to reintegrate low-skilled workers into the labor market. This paper aims at analyzing the policy instrument of tax credits in a theoretical model that systematically compares its costs and benefits in the context of the German system of apprenticeship training and social security. Building on recent training literature, a two-period partial-equilibrium model is developed that allows for worker heterogeneity in ability. In our model, the implementation of tax credits in terms of a negative income tax solves a trade-off with respect to overall welfare. While tax credits reduce the number of unemployed workers at the extensive margin, they increase at the same time the opportunity costs of apprenticeship training, which implies that human capital formation is decreased. Furthermore, the model suggests that the reintegration of those workers at the bottom of the ability-distribution into the labor market is not optimal. The additional implementation of minimum wages is counteractive to the reduction of unemployment because firms would thus be prevented from employing workers with very low productivities.