savings (savings by institutions or households) are assumed to adjust and the economic and welfare effects are driven primarily by changes in net household income and consumption as the cost of higher wage subsidies filter through the economy.

Unlike traditional tax models, however, there will be a resource effect as the subsidy will lower wage cost and raise employment given the labor market behavior of the model. The structural features of the labor markets in South Africa are treated in a similar fashion as in Essama _et al._ (2007), Go _et al._ (2005) and Lewis (2001). Structural unemployment is specified for low-skilled and semi-skilled formal workers, with sticky real wages, while the other labor markets clear in equilibrium. All other factors are mobile across all production activities and are fully employed, with the exception of capital in agriculture, coal, gold, and other mining which are treated as activity specific.<sup>15</sup> The wage subsidy is introduced much like a “negative wage tax” that lowers the labor cost to employers; it affects only the low-skilled and semi-skilled workers where significant unemployment exists, but covers employers in all activities except coal, gold, other minerals, petroleum, and government services. Although there are already great details in terms of sectors and labor categories, the CGE model cannot target further the wage subsidy to the young or new job entrants, as for example formulated by Levinsohn (2008), without the additional complexity of adding a demographic component to labor market behavior. Likewise, at the micro-simulation level explained below, an increase in employment is drawn from the pool of unemployed among the low- and semi-skilled based primarily on their economic and individual characteristics (such as education, experience, gender, etc.) that affect their probabilities of being hired. The incorporation of demographic dynamics is clearly an area for future research.

In the government budget, government savings are ‘flexible’, but with investment and government spending fixed, this is just a modeling device to shift the adjustment to the households. It is in fact equivalent to the imposition of a lump-sum tax on household income. The wage subsidy is therefore not free and the fiscal cost will depend on the interaction among the resource effects of increased employment and gross domestic product (GDP), the dampening effects on household income from the implied lump-sum tax, and their economy-wide effects on the revenue of existing taxes. One advantage of a general equilibrium approach is that all the economy-wide or direct and indirect effects are observed. Since tax revenue from other sources will likely adjust upward, the net cost of the program is not the full expenditure on wage subsidies. What is not financed from the revenue effect of existing taxes is the net fiscal cost; it is also the size of the implied lump-sum tax on households. Because the first best option of lumpsum taxation is normally not feasible, we also look at a real or existing tax instrument like the social security tax and examine the implications for changes in household income taxes following a wage subsidy as well as possible distributional impacts.

**_Micro-behavior of labor and households._** A micro-simulation model is used to explain the income generation processes and the expenditure patterns at the household level based on parameterization of the information contained in the household survey data.  The LFS provides

> income/consumption/welfare.  To examine the impact on household income and welfare, those links will need to be spelled out.

> 15 With this specification, we present a long run view of the adjustment process, achieving equilibrium sectoral employment except those sectors in which capital is assumed to be sector-specific.

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