Labour supply project: Model of labour market transitions - estimations and results

This document presents details of the estimation and results from the IFS model of labour market transitions. We build on the methodology presented in Report 2 from this project (с Dynamic Model of Labour Market Transitions and Work Incentives' by Michal Myck and Howard Reed) where we proposed dividing the overall estimation procedure into four major modelling stages:

1. The estimations used to produce the inputs for tax and benefit modelling. This stage includes equations for wages, hours worked and childcare cost. This stage is carried out using the Labour Force Survey (LFS) (for entry wage equations) and the Family Resources Survey (FRS) (for other estimations).
2. The tax and benefit modelling stage. Estimated ѩngredients' from stage one of the estimation process are fed into the tax and benefit model, TAXBEN, to give estimates of net incomes in various labour market states. TAXBEN is run on the FRS data.
3. The take-up modelling stage. This stage involves the estimation of take-up equations in the FRS following the net income calculations in TAXBEN. We model take-up of FC/WFTC and take-up of paid childcare. Since the tax and benefit modelling is done on the FRS, the take-up regressions are also run on FRS data.
4. Final labour market transitions modelling. This is the final stage of the modelling and is based on labour market information from the LFS. Transitions are made conditional on financial incentives ѩmported' at a group-level basis from the FRS after the first three stages of estimation.

We refer to these four stages throughout this document, and discuss and report results from stages 1, 3 and 4 of the modelling process, focusing on the analysis of the final dynamic model of labour supply.

The analysis presented in this document is divided into four sections. In section 1 we present the data used in the model. The section includes a brief discussion of the sample selection criteria and provides information on the FRS and LFS samples which we use in the estimations. As we argued in Report 2, because the overall model combines several modelling stages, the estimation of the financial incentives variables which are finally used in stage 4 of the modelling can be done using several different approaches. In section 2 we present the most important of these approaches. An outline of our preferred definition of the measure of financial incentives is presented in section 3, together with the results of our preferred specifications of the final model of labour market transitions for singles and couples. Section 4 reports the results of some simulations of tax and benefit reforms using the model of labour market transitions. Section 5 concludes.