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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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    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;

    This paper has been announced in the following NEP Reports:

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    1. Rasmus Lentz, 2009. "Optimal Unemployment Insurance in an Estimated Job Search Model with Savings," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(1), pages 37-57, January.
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    4. Daron Acemoglu & Robert Shimer, 1999. "Productivity Gains from Unemployment Insurance," Working papers 99-29, Massachusetts Institute of Technology (MIT), Department of Economics.
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    25. Gaure, Simen & Røed, Knut & Westlie, Lars, 2008. "The Impacts of Labor Market Policies on Job Search Behavior and Post-Unemployment Job Quality," IZA Discussion Papers 3802, Institute for the Study of Labor (IZA).
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    Citations

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

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