Optimal Unemployment Benefits Research Articles

Monopolistic competition, rising markups, and optimal taxation of participation

AbstractThis study explores the optimal taxation of participation within a monopolistically competitive product market that exhibits increasing markups. Individual labor supply responds along both intensive and extensive margins. The government simultaneously optimizes a nonlinear Mirrleesian income tax scheme, a flat profit tax rate, and a flat unemployment benefit. It is shown analytically that the monetized welfare cost of an increase in unemployment benefit is higher under monopolistic competition compared to under perfect competition. Nevertheless, numerical simulations suggest that the optimal unemployment benefit increases in response to greater markups when the government simultaneously optimizes all of its tools. The reason is that, along with a higher profit tax, rising markups require a decline in marginal income taxes. Lower marginal income taxes relieve the extensive margin distortions and accommodate an increase in the unemployment benefit. Accordingly, optimal nominal participation taxes remain approximately unchanged for the lower half of the ability distribution. For the upper half, the decline in income taxes outweighs the increase in the unemployment benefit, leading to lower optimal nominal participation taxes.

Optimal income taxation in unionized labor markets

This paper extends the Diamond (1980) model with labor unions to study optimal income taxation and to analyze whether unions can be desirable for income redistribution if income taxes are optimized. Unions bargain with firms over wages in each sector and firms unilaterally determine employment. Optimal unemployment benefits and optimal income taxes are lower in unionized labor markets. Unions raise the efficiency costs of income redistribution, because unemployment benefits and income taxes raise wage demands, and thereby generate involuntary unemployment. We show that unions are socially desirable only if they represent (low-income) workers whose participation is subsidized on a net basis. By creating implicit taxes on work, unions alleviate the labor-market distortions caused by income taxation. We empirically verify whether (i) participation tax rates are lower if unions are more powerful, and (ii) unions are desirable by compiling our own data set with union densities and participation tax rates for 18 sectors in 23 advanced countries. In line with our theoretical predictions, we find that participation tax rates are lower if unions are stronger. Moreover, the desirability condition for unions is never met empirically. Numerical simulations for the Netherlands confirm that unions are not desirable if income taxes are optimized and optimal participation taxes are lower if unions are stronger.

Redistributive Unemployment Benefit and Taxation

Abstract This paper suggests a simple rule which identifies the coordination between optimal unemployment benefits paid and the tax system in the case of risk neutral workers but with moral hazard and hidden information on the worker’s type. Our model posits that, given a universal, linear income tax scheme, the optimal unemployment benefits paid does not depend on workers’ types. Standard government policy pays a positive replacement rate to unemployed workers. Optimal redistribution, taking moral hazard and adverse selection into account, instead suggests that the benefit paid should be the same for all and only depends on the underlying tax structure.

Income-Contingent Loans as an Unemployment Benefit

Imperfections in risk and capital markets imply that individuals who lose jobs suffer from imperfect smoothing of consumption across states and times. Compared to the first best, there will be too little search. Optimal unemployment programs, which balance the marginal benefit of consumption smoothing vs. the marginal cost of the insurance externality, increase welfare and may even increase GDP. Our analytical results suggest that welfare is higher if the unemployment benefits program includes income-contingent unemployment loans (ICL), where the amount repaid depends on the individual’s future income. Such loans can be financed by a risk premium imposed on the unemployed who avail themselves of the loans, and partially substitute for unemployment insurance (UI) benefits. Optimal unemployment benefits programs (UB) with ICL do a better job of smoothing consumption across states and time, and in particular total benefits when unemployed increase. We analyze how changes in key parameters, such as the degree of risk aversion and the nature of post-employment work, affect the design of the optimal UB program and the magnitude of the incremental benefits from including income-contingent loans. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Endogenous Unemployment Benefits in an Equilibrium Job Search Model over the Life-Cycle

By being indexed backwards on the wage, wage-indexed unemployment benefits have the particularity to grow over the workers' life cycle. In this paper we build an equilibrium job search model with the life cycle of workers to assess the effect of this shape of unemployment benefits taking into account this life cycle dimension. In this model, as workers' productivity tends to rise with age, the monopsony power that firms can exploit extends with age as well. This monopsony power is known to generate inefficient turnover and can be reduced by implementing unemployment benefits. As wage-indexed unemployment benefits (WIUB) grow over the workers' life cycle, despite their negative effect on employment already discussed by Burdett and Mortensen (1998) and ChA©ron and Langot (2010), WIUB can reduce the inefficient turnover all over the life cycle and be better suited to restore the efficient allocation on the labour market than Beveridgian unemployment benefits. Thanks to the simulation of the model, we find that in that case, the optimal unemployment benefits are wage-indexed at a replacement rate equal to 44%.

Optimal Unemployment Benefits in the Pandemic

How should unemployment benefits vary in response to the economic crisis induced by the COVID-19 pandemic? We answer this question by computing the optimal unemployment insurance response to the COVID-induced recession.We compare the optimal policy to the provisions under the CARES Act—which substantially expanded unemployment insurance and sparked an ongoing debate over further increases—and several alternative scenarios. We find that it is optimal first to raise unemployment benefits but then to begin lowering them as the economy starts to reopen — despite unemployment remaining high. We also find that the $600 UI supplement payment implemented under CARES was close to the optimal policy. Extending this UI supplement for another six months would hamper the recovery and reduce welfare. On the other hand, a UI extension combined with a re-employment bonus would further increase welfare compared to CARES alone, with only minimal effects on unemployment.

Optimal Income Taxation in Unionized Labor Markets

This paper extends the Diamond (1980) model with labor unions to study optimal income taxation and to analyze whether unions can be desirable for income redistribution. Unions bargain with firms over wages in each sector and firms unilaterally determine employment. Unions raise the efficiency costs of income redistribution, because unemployment benefits and income taxes raise wage demands and thereby generate involuntary unemployment. Optimal unemployment benefits and optimal income taxes are lower in unionized labor markets. We show that unions are socially desirable only if they represent (low-income) workers whose participation is subsidized on a net basis. By creating implicit taxes on work, unions alleviate the labor-market distortions caused by income taxation. Numerical simulations demonstrate that optimal taxes and transfers are much less redistributive in unionized labor markets than in competitive labor markets.

Optimal unemployment benefits in the presence of informal labor markets

We assess optimal unemployment benefit level and duration in a labor market with many informal jobs. Using administrative data from Argentina, a country with high informality, we exploit discontinuities in duration, and a reform that increases benefits. We find that increasing benefits hardly extends unemployment spells but raises re-employment wages. In contrast, extending unemployment benefits prolongs unemployment spells with no effect on re-employment wages. In a search model, we derive sufficient statistics to analyze the welfare effects of a reform that increases benefits by shortening duration. Calibrating our formula using our empirical results, we find that welfare would increase with higher benefits and shorter duration.

Optimal unemployment benefit policy and the firm productivity distribution

This paper provides a novel justification for a declining time profile of unemployment benefits that does not rely on moral-hazard or consumption-smoothing considerations. We consider a simple search environment with homogeneous workers and low- and high-productivity firms. By introducing a declining time profile of benefits, the government can affect the equilibrium wage profile in a manner that enhances the sorting of workers across low- and high-productivity firms. We demonstrate that optimal government policy depends on the dispersion and skewness of the firms’ productivity distribution.

Matching, sorting and wages

We develop an empirical search-matching model which is suitable for analyzing the wage, employment and welfare impact of regulation in a labor market with heterogeneous workers and jobs. To achieve this we develop an equilibrium model of wage determination and employment which extends the current literature on equilibrium wage determination with matching and provides a bridge between some of the most prominent macro models and microeconometric research. The model incorporates productivity shocks, long-term contracts, on-the-job search and counter-offers. Importantly, the model allows for the possibility of assortative matching between workers and jobs due to complementarities between worker and job characteristics. We use the model to estimate the potential gain from optimal regulation and we consider the potential gains and redistributive impacts from optimal unemployment benefit policy. Here optimal policy is defined as that which maximizes total output and home production, accounting for the various constraints that arise from search frictions. The model is estimated on the NLSY using the method of moments.

PROTOCOL: Reducing Unemployment Benefit Duration to Increase Job Finding Rates: Protocol for a Systematic Review

PROTOCOL: Reducing Unemployment Benefit Duration to Increase Job Finding Rates: Protocol for a Systematic Review

Optimal unemployment insurance in an equilibrium business-cycle model

The optimal cyclical behavior of unemployment insurance is characterized in an equilibrium search model with risk-averse workers. Contrary to the current US policy, the path of optimal unemployment benefits is pro-cyclical – positively correlated with productivity and employment. Furthermore, optimal unemployment benefits react non-monotonically to a productivity shock: in response to a fall in productivity, they rise on impact but then fall significantly below their pre-recession level during the recovery. As compared to the current US unemployment insurance policy, the optimal state-contingent unemployment benefits smooth cyclical fluctuations in unemployment and deliver substantial welfare gains.

Search frictions, real wage rigidities and the optimal design of unemployment insurance

In this paper, we study the optimal unemployment benefits financing scheme when the economy is subject to labor market imperfections characterized by real wage rigidities and search frictions. The US unemployment insurance financing is such that firms are taxed proportionately to their layoffs to finance unemployment benefits. Using DSGE methodology, we investigate how policy instruments should interact with labor market imperfections. It is shown that wage rigidities in a search and matching environment cause welfare costs, especially in the absence of an incentive-based unemployment insurance. This cost is mainly due to the distorting effect of wage rigidities which generate inefficient separations. We show that the optimal unemployment benefits financing scheme – corresponding to the Ramsey policy – offsets labor market imperfections and allows implementation of the Pareto allocation. The second-best allocation brings the economy close to the Ramsey allocation. The implementation of the optimal policies clearly highlights the role of labor market institutions for short-run stabilization.

Unemployment Benefits or Taxes: How Should Policy Makers Redistribute Income Over the Business Cycle?

This paper studies optimal unemployment benefit levels and optimal proportional income tax rates over the business cycle. Previous research suggests that policy makers should make unemployment insu ...

A Macroeconomic Model for the Evaluation of Labor Market Reforms

We develop a tractable macroeconomic model with employment risk and labor market search in order evaluate the effects of labor market reform on unemployment, growth, and welfare. The model has a large number of risk-averse households who can invest in risk-free physical capital and risky human capital. Unemployed households receive unemployment benefits and decide how much search effort to exert. We present a theoretical characterization result that facilitates the computation of equilibria substantially. We calibrate the model to German data and use the calibrated model economy to simulate the macroeconomic effects of the German labor market reforms of 2005 and 2006 (Hartz Reforms). We find that the 2005-reform had large employment effects: the equilibrium unemployment rate has been reduced by approximately 1.1 percentage points from 7.5 to 6.4 percent. Moreover, the drop in unemployment has led to substantial output gains. Finally, employed and short-term unemployed households experienced significant welfare gains, whereas the long-term unemployed have lost in welfare terms. The effects of the 2006-reform are qualitatively similar, but quantitatively much smaller. We also show that the social welfare maximizing replacement rate is lower than the current (post-reform) replacement rate in Germany. However, implementing the optimal unemployment benefit system generates only small welfare gains.

Unemployment Benefits as a Means for Optimal Redistribution

This paper explores the rationale for unemployment benefits as a complement to optimal nonlinear income taxation. We find under plausible assumptions that the optimal unemployment benefits targeted at the low-skilled will be higher than the pure insurance and efficiency purposes would prescribe. The paper thus gives a theoretical justification for using unemployment benefits for redistribution.