Social program substitution and optimal policy

Abstract

The large size and rate of growth of the US Disability Insurance (DI) system makes it important to understand the factors that influence the decision to apply for DI. In a context of imperfect DI screening, the generosity of other social programs can play a role in this decision, and one empirically relevant factor is the availability and generosity of Unemployment Insurance (UI) benefits. UI's impact on DI applications and enrollment has been ignored in welfare analyses of UI, but I show that it leads to significantly altered results: the optimal level of unemployment benefits increases by about 50%, as more generous UI prevents workers from applying for DI, with significant cost savings to the government. The same logic applies to a wide variety of other social programs and contexts, and in a more general model I show that the impact of any such program on welfare can be expressed in terms of its redistributional effect and its effects on the tax base and on enrollment on other programs.