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Fiscal Externalities and Optimal Unemployment Insurance

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  • Nicholas Lawson

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

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    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%.

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    File URL: http://www.amse-aixmarseille.fr/sites/default/files/_dt/2012/wp_2013_-_nr_57.pdf
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    Bibliographic Info

    Paper provided by Aix-Marseille School of Economics, Marseille, France in its series AMSE Working Papers with number 1357.

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    Length: 55 pages
    Date of creation: 21 Nov 2013
    Date of revision: 21 Nov 2013
    Handle: RePEc:aim:wpaimx:1357

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    Web page: http://www.amse-aixmarseille.fr/en
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    Related research

    Keywords: unemployment insurance; fiscal externality; job search; sufficient statistics; government spending;

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    Cited by:
    1. Nicholas Lawson, 2014. "Liquidity Constraints, Fiscal Externalities and Optimal Tuition Subsidies Optimal College Tuition Subsidies," AMSE Working Papers 1404, Aix-Marseille School of Economics, Marseille, France, revised 18 Mar 2014.
    2. Nicholas Lawson, 2014. "Social Program Substitution and Optimal Policy," Working Papers halshs-00993127, HAL.
    3. Nicholas Lawson, 2014. "Liquidity Constraints, Fiscal Externalities and Optimal Tuition Subsidies," Working Papers halshs-00964527, HAL.
    4. Nicholas Lawson, 2014. "Social Program Substitution and Optimal Policy," AMSE Working Papers 1417, Aix-Marseille School of Economics, Marseille, France, revised 16 May 2014.

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