Subsidies on low skilled's social security contributions: the case of Belgium

Belgium is characterised by a comparatively high tax wedge. Starting from the end of the 90’s there has been a growing concern over the effect of high labour costs on the employment of low skilled workers. One of the most innovative measures implemented by the federal government is the targeted reduction on social security contributions for low skilled workers: the Workbonus. The subsidy has increased steadily over the period 2000-2006. At the same time the eligibility to the benefit was considerably extended. The innovative feature of the tax credit is that - differently from other measure existing in OECD countries - eligibility is based on full-time equivalent earnings. The instrument therefore distinguishes between low skill and low effort and avoids the disincentive effect on labour supply at the intensive margin that is typically found in traditional measures means-tested on disposable income or earnings. This paper assesses the effects of the Workbonus on labour supply using different econometric frameworks. In particular, we compare estimates based on a traditional labour supply model, with results based on a modeling framework which accounts for heterogeneity in individuals’ job opportunities. Results show that accounting for demand side constraints leads to significantly lower estimates of labour supply effects. Nevertheless, the measure has a positive impact on labour supply and comparatively low cost per additional job created.