Replacement Rates, Unemployment and Poverty Traps

On the 4th of December the Department of Finance published a short report on Replacement Rates and Unemployment. The six-page document can be accessed here.

What are Replacement Rates?

The replacement rate for given income levels measures the proportion of out-of-work benefits received when unemployed against take home pay if in work. While there is no pre-determined level of replacement rate which would influence every individual’s decision to work, clearly the higher the replacement rate, the lower the incentive to work. A replacement rate in excess of 70% is considered to be excessive.

Thus it is a measure of how much of a person's family income would be replaced if they were to lose their job/income and start receiving social welfare. Why they are of concern in Ireland is nice captured in this letter which appeared in The Irish Independent back in April. Andy's friend may be imaginary but the general argument is true.

High replacement rates lead to Unemployment Traps which occur

"when a person’s out-of-work family disposable income compares favourably with his/her in-work family disposable income, thereby resulting in disincentives to work.

A related problem are Poverty Traps which occur

"for those in employment when an increase in an employed person’s gross income results in a reduction in net income, thereby resulting in disincentives to work for higher earnings or work for increased hours. This can arise because of a move into a higher tax bracket or because of withdrawal of social benefits as gross income crosses certain thresholds."

The Department produces replacement rates for three income levels

1. The national minimum wage (NMW) = €17,542
2. 67% of the average industrial earnings (AIE) = €22,535
3. The average industrial earnings (AIE) = €33,634

and they are reproduced in the following table.

Summary:

• Single people with no children (28% of Live Register cases) face high replacement rates at the national minimum wage, although below 70%. Replacement rates are not an issue for higher earning single people.
• Couples with no children where both are not working (10% of Live Register) face high replacement rates at each income level up to AIE, though these are under 70% except at NMW.
• Couples with one or two children where both are not working (5% of Live Register)have higher replacement rates again. These are 70% and above for couples with one or two children who would earn at two thirds AIE (c. €22,500) or less.
• One-Parent Families (29% of Live Register cases) have low replacement rates except where out-of-work income is supplemented by Community Employment Scheme (CES) earnings.
• There are significant welfare benefits for couples for one working at NMW or two thirds AIE; as the other spouse can claim entitlement to means tested JA.
• Rent supplement has the potential to introduce significant disincentives to work and is received by 12% of cases on the Live Register.

For example, of couple claimants in receipt of rent supplement 43% have no children and they could face replacement rates as high as 102% if the maximum rate of rent supplement (based on Dublin rates for a couple with no children) was paid out-of-work and no rent supplement paid while in-work, i.e. they would have a higher family income if they remain out-of-work!

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