The importance of having a more realistic welfare transfer determination rule: A CGE analysis for Ireland

Abstract

While unemployment benefits constitute a significant share of welfare transfers in developed countries, the computable general equilibrium (CGE) literature ignores the impact of unemployment rate changes on these transfers. This paper investigates the impacts of alternative welfare transfer determination rules by using a dynamic CGE model for Ireland. We find that indexing the nominal welfare transfer budget to the consumer price index (CPI) and the aggregate unemployment rate is superior to the CPI alone. Although both specifications generate similar macroeconomic outcomes, our novel specification improves household welfare as well as income distribution across households. We argue that it is more in line with the behaviour of governments and that the literature ignores the progressivity elements embedded in the welfare system, which will reduce the welfare cost of carbon taxation. The results can be generalised in analysing the impacts of tax reform in countries where unemployment benefits are essential elements of welfare transfers.