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Fiscal Externalities and Optimal Unemployment Insurance

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  • Nicholas Lawson

    (Aix-Marseille University (Aix-Marseille School of Economics), CNRS & EHESS)

Abstract

A common finding of the optimal unemployment insurance literature is that the optimal UI replacement rate is around 50%, implying that current levels in the US are close to optimal. However, a key assumption in the existing literature is that unemployment benefits are the only government spending activity. In this paper I show that recommendations for optimal UI levels are dramatically reduced when one incorporates the fact that UI spending is a small part of overall government spending. This occurs because the negative impact of UI on income tax revenues implies added welfare costs, a mechanism that I refer to as a fiscal externality. Using both a calibrated structural job search model and a "sufficient statistics" method that relies on reduced-form elasticities, I find that the optimal replacement rate drops to zero once fiscal externalities are incorporated. However, I also consider the possibility that more generous UI could increase reservation wages and thus potentially increase the tax base, and I show that this second fiscal externality could have important effects on the results, with an optimal replacement rate which could rise above 70%.

Suggested Citation

  • Nicholas Lawson, 2013. "Fiscal Externalities and Optimal Unemployment Insurance," AMSE Working Papers 1357, Aix-Marseille School of Economics, France, revised 21 Nov 2013.
  • Handle: RePEc:aim:wpaimx:1357
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    2. Nicholas Lawson, 2017. "Liquidity Constraints, Fiscal Externalities, and Optimal Tuition Subsidies," American Economic Journal: Economic Policy, American Economic Association, vol. 9(4), pages 313-343, November.
    3. Juliana MESÉN VARGAS & Bruno VAN DER LINDEN, 2017. "Is there always a trade-off between insurance and incentives? The case of unemployment with subsistence constraints," LIDAM Discussion Papers IRES 2017014, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
    4. Pattison, Nathaniel, 2020. "Consumption smoothing and debtor protections," Journal of Public Economics, Elsevier, vol. 192(C).
    5. Manasi Deshpande & Tal Gross & Yalun Su, 2019. "Disability and Distress: The Effect of Disability Programs on Financial Outcomes," Working Papers 2019-020, Human Capital and Economic Opportunity Working Group.
    6. Camarero Garcia, Sebastian & Murmann, Martin, 2020. "Unemployment benefit duration and startup success," ZEW Discussion Papers 20-033, ZEW - Leibniz Centre for European Economic Research.
    7. Arash Nekoei & Andrea Weber, 2017. "Does Extending Unemployment Benefits Improve Job Quality?," American Economic Review, American Economic Association, vol. 107(2), pages 527-561, February.
    8. Ferey, Antoine, 2022. "Redistribution and Unemployment Insurance," Rationality and Competition Discussion Paper Series 345, CRC TRR 190 Rationality and Competition.
    9. David S. Lee & Pauline Leung & Christopher J. O’Leary & Zhuan Pei & Simon Quach, 2021. "Are Sufficient Statistics Necessary? Nonparametric Measurement of Deadweight Loss from Unemployment Insurance," Journal of Labor Economics, University of Chicago Press, vol. 39(S2), pages 455-506.
    10. Pauline Leung & Christopher O'Leary, 2020. "Unemployment Insurance and Means-Tested Program Interactions: Evidence from Administrative Data," American Economic Journal: Economic Policy, American Economic Association, vol. 12(2), pages 159-192, May.
    11. Xiuming Dong & Johanna Catherine Maclean & David Powell, 2024. "Social Insurance Spillovers: Evidence From Paid Sick Leave Mandates and Workers' Compensation," NBER Working Papers 32751, National Bureau of Economic Research, Inc.
    12. Nicholas Lawson, 2023. "Optimal unemployment policy," Economic Inquiry, Western Economic Association International, vol. 61(3), pages 675-692, July.
    13. Lawson, Nicholas, 2015. "Social program substitution and optimal policy," Labour Economics, Elsevier, vol. 37(C), pages 13-27.
    14. Manasi Deshpande & Tal Gross & Yalun Su, 2021. "Disability and Distress: The Effect of Disability Programs on Financial Outcomes," American Economic Journal: Applied Economics, American Economic Association, vol. 13(2), pages 151-178, April.
    15. Wang, Cheng & Williamson, Stephen D., 2002. "Moral hazard, optimal unemployment insurance, and experience rating," Journal of Monetary Economics, Elsevier, vol. 49(7), pages 1337-1371, October.
    16. Nicholas Lawson, 2014. "Liquidity Constraints, Fiscal Externalities and Optimal Tuition Subsidies Optimal College Tuition Subsidies," AMSE Working Papers 1404, Aix-Marseille School of Economics, France, revised 18 Mar 2014.
    17. Jonathan Cohen & Geoffrey C. Schnorr, 2024. "Efficiency Costs of Unemployment Insurance Denial: Evidence from Randomly Assigned Examiners," Upjohn Working Papers 24-404, W.E. Upjohn Institute for Employment Research.

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    More about this item

    Keywords

    unemployment insurance; fiscal externality; job search; sufficient statistics; government spending;
    All these keywords.

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search
    • J65 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment Insurance; Severance Pay; Plant Closings

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