Originally published here.

This study provides insight in the responsiveness of disabled workers to financial incentives, using administrative individual data from the Netherlands from 2006 to 2013. We focus on workers receiving partial DI benefits and with substantial residual work capacities that can be exploited. After the first phase of benefit entitlement, workers that do not use their residual income capacity experience a large drop in benefit income. In effect, this implies a substantial increase in incentives to resume work. With entitlement periods in the first phase of DI benefits varying across individuals, we use a difference-in-difference approach to analyze the effects on the incidence of work, the wage earnings and full work resumption of disabled workers. Based on the effect estimate on work incidence, we infer a labor elasticity rate of Elasticity estimates are highest among younger DI recipients, as well as individuals with mental impairments. The incentive change has only a limited impact on wage earnings of partially disabled workers and no significant impact on work resumption rates.

In recent years, more attention has been devoted to the design of work incentives of disabled workers (OECD, 2010). Several studies point at the presence of residual work capacities among disability insurance (DI) recipients, see e.g. Bound (1999) and Maestas et al. (2014). At the same time, there is a common belief that disabled workers are discouraged from using these capacities by a lack of financial incentives. Workers that increase their working hours are faced with high implicit tax rates or may even loose their (full) DI benefits. This may explain why outflow rates of DI recipients are typically low, even if their impairments are expected to be temporary (Koning and Lindeboom, 2015). Related to this point, low take-up rates of Ticket-to-Work vouchers in the US Social Security Disability Insurance (SSDI) illustrate that the impact of wage subsidies – as a complement to partial DI benefits – do not compensate for perverse incentives (Autor and Duggan, 2006).

The success of reforms that aim at enhancing the implicit tax rates on work critically hinges on the responsiveness of disabled workers to changes in work incentives. In particular, labor elasticities may vary with respect to the severity of impairments and their evolution – as well as the general loss of work capabilities – over time. One of the key empirical questions in the design of DI benefit schemes thus is how impairments affect the ability of workers to respond to – and benefit from incentives.

In this context, possible responses are twofold: workers may increase their work effort to complement DI benefits, or leave the DI scheme if benefit conditions become less generous. This study provides insight in the responsiveness of disabled workers to financial incentives, using administrative individual data from the Netherlands from 2006 to 2013. We focus on workers that receive partial DI benefits and have substantial residual work capacities that can be exploited. In the first phase of benefit entitlement – the so called ‘wage-related period’ – DI benefits are supplemented with Unemployment Insurance (UI) benefits if the residual income capacity is left unused.

In principle, this ensures the payment of benefits of at least 70% of the individual’s pre-disability wage. When the wage related period ends and the UI benefit period is exhausted, however, workers that do not use their residual income capacity receive DI benefits that are based on the statutory minimum wage instead of their pre-disability wage. This induces a large drop in the income from benefits for most workers. However, workers that use their residual work capacity receive benefit levels that are (still) related to their pre-disability wage. In effect, most partially disabled workers experience a strong increase in work incentives – with large potential drops in benefits – at the moment the wage-related DI benefit period has been exhausted.

This paper provides insight in the responsiveness of disabled workers to financial incentives, using administrative individual data from the Netherlands. We focus on workers receiving partial DI benefits and with substantial residual work capacity that can be exploited. After the first phase of DI benefit entitlement, workers that do not use their residual income capacity experience a large drop in their benefit income. As entitlement periods in the first phase of DI benefits vary across individuals, we can use a DiD approach to analyze the effects of this incentive change on the incidence of work, the wage earnings and (full) work resumption of disabled workers. Based on the effect estimate on work incidence, we infer a labor elasticity rate of 0.12. The incentive change has only a limited impact on wage earnings of partially disabled workers and no significant impact on work resumption rates. Further, labor supply effects are largest among younger workers and those with mental impairments.

From a policy perspective, there are least three lessons that can be drawn from our analysis. First, our results stress the importance of work continuation in the sickness period that precedes entitlement to DI benefits. Most employed individuals in our sample succeeded in maintaining employment until the DI claims assessment. Albeit significant, the additional impact of financial incentives among workers without employment at the start of DI benefit receipt is relatively small. Second, our results confirm earlier work that disabled worker respond to earnings disregards and wage subsidies that complement DI benefits, rather than inducing individuals to leave the DI scheme (Campolieti and Riddell 2012; Weathers and Hemmeter 2011).

In the context of the Dutch DI scheme, partially disabled workers had an interest in exploiting their residual earnings capacity but avoided the imposition of medical assessments that would lower their DI benefits. As a result, increases in wage earnings of already employed individuals were limited. In the time period under investigation, DI recipients were typically scheduled to have medical reassessments only if they had experienced substantial increases in wage earnings. With this in mind, one may consider a more frequent and focused use of medical reassessments, so as to prevent the occurrence of cash cliffs (see also Moore, 2015).

Alternatively, one may opt to design incentive schemes that also reward full work resumption or allow for temporary extensions of benefit entitlement if wage earnings exceed the maximum level for eligibility to DI benefits. Finally, we find high response effects of financial incentives are confined to younger workers. This explains why younger workers with low DI benefit entitlement to the more generous wage-related period are more responsive to the incentive change. When controlling for such age effects, there is no evidence that the incentive change also decreases with respect to the length of DI benefit entitlement. Thus, employment effects of shortening DI benefit entitlement are probably limited.

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