There Are Ways to Improve Work Incentives Without Increasing Income Inequality

The Finnish unemployment system is inefficient. The earnings-related unemployment allowance unnecessarily lengthens the duration of unemployment spells. Longer unemployment spells increase income differences compared to a situation where a larger share of the population earned their living at paid work. This is because the prolongation of the unemployment spell means lower income for a longer period. Longer unemployment spells are also likely to contribute negatively to the quality of post-unemployment jobs. In this Brief, we sketch a reform that improves the work incentives of the unemployed with low employment barriers. The reform consists of shortening the duration of the earnings-related unemployment allowance from the current 400 days to a maximum of 200–250 days (9–12 months) and using the savings to support the employment of the people with the highest employment barriers. As a result, the unemployed entitled to the earnings-related unemployment allowance return to work more quickly, while long term unemployment decreases, and so the reform does not increase income inequality.