will find LTU attractive when welfare assistance increases. The derivative ∂hA∕∂s indicates that
this effect will be large for those with high rates of human capital degradation.
Some researchers hold generous welfare assistance responsible for continental Europe’s unem-
ployment problem. A single LTU with children, for example, who would live on food stamps in
the U.S. receives in Germany Sozialhilfe of 648 Euros per month (including support for housing
and heating). Sozialhilfe for other types of households is higher. A couple with two children,
for example, receives on average 1601 Euros per month. Several other European countries oper-
ate social welfare of comparable generosity (European Commission, 2004). For Germany, Boss
(2001) and Sinn et al. (2002) calculate marginal tax rates on (potential) low-wage income of the
recipients of social welfare between 80 and 100 percent. Sinn et al. conclude that it does not
pay to work for a head of a West German household with two children if his or her productivity
is below 50 percent of average productivity.
In the career decision diagram more generous welfare assistance shifts hA to the right. This
moves social benefits above net wage income for a larger fraction of the h-ordered population
and higher long-term unemployment in the low-productivity segment of the labor market results.
The magnitude of this effect is predicted to be large when taxes on (potential) labor income are
high.
3.4. Taxation. Higher taxes on labor income increase LTU because they discourage some low-
skill STU to exit unemployment. Hence, STU falls. STU may fall for a second reason. Higher
taxes may also reduce STU because they make retraining for high-skill persons less profitable.
In Figure 1, a higher tax rate on labor income θ moves hA to the right and shifts hC left, if
anything.
∂hA δτ s + ce
~θθ~ = δτ(1 - θ)2(1 - d) >
∂hC ce
~θθ = - (1 - θ)2 [⅛r(1 - b) + δτd] ≤ .
Higher taxes reduce the net payoff from working and increase LTU. Note that the effect is
particularly strong if retraining is, in principle, worthwhile (e > 0). Some low-productivity
workers who would have used an STU spell to upgrade their skills when taxes are low are now
facing a lower net return of re-education after the tax increase and prefer to stay on the dole
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