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A General Formula for the Optimal Level of Social Insurance

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Author Info
Raj Chetty

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Abstract

In an influential paper, Baily (1978) showed that the optimal level of unemployment insurance (UI) in a stylized static model depends on only three parameters: risk aversion, the consumption-smoothing benefit of UI, and the elasticity of unemployment durations with respect to the benefit rate. This paper examines the key economic assumptions under which these parameters determine the optimal level of social insurance. A Baily-type expression, with an adjustment for precautionary saving motives, holds in a very general class of dynamic models subject to weak regularity conditions. For example, the simple reduced-form formula derived here applies with arbitrary borrowing constraints, endogenous insurance markets, and search and leisure benefits of unemployment. A counterintuitive aspect of this result is that the optimal benefit rate appears not to depend on (1) any benefit of UI besides consumption-smoothing or (2) the relative magnitudes of income and substitution effects in the link between UI benefits and durations. However, these parameters enter implicitly in the optimal benefit calculation, and estimating them can be useful in testing whether the values of the primary inputs are consistent with observed behavior.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11386.

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Date of creation: May 2005
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Handle: RePEc:nbr:nberwo:11386

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H5 - Public Economics - - National Government Expenditures and Related Policies

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Martin Feldstein, 2005. "Rethinking Social Insurance," American Economic Review, American Economic Association, vol. 95(1), pages 1-24, March. [Downloadable!]
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  2. Moffitt, Robert, 1985. "Unemployment insurance and the distribution of unemployment spells," Journal of Econometrics, Elsevier, vol. 28(1), pages 85-101, April. [Downloadable!] (restricted)
  3. Meyer, Bruce D, 1990. "Unemployment Insurance and Unemployment Spells," Econometrica, Econometric Society, vol. 58(4), pages 757-82, July. [Downloadable!] (restricted)
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  4. Anderson, Patricia M & Meyer, Bruce D, 1997. "Unemployment Insurance Takeup Rates and the After-Tax Value of Benefits," The Quarterly Journal of Economics, MIT Press, vol. 112(3), pages 913-37, August.
  5. Thomas Crossley & Hamish Low, 2005. "Borrowing constraints, the cost of precautionary saving and unemployment insurance," IFS Working Papers W05/02, Institute for Fiscal Studies. [Downloadable!]
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  6. Martin Browning & Thomas F. Crossley, 2004. "Shocks, stocks and socks: smoothing consumption over a temporary income loss," CAM Working Papers 2004-05, University of Copenhagen. Department of Economics. Centre for Applied Microeconometrics. [Downloadable!]
  7. Jacob Mincer, 1962. "Labor Force Participation of Married Women," NBER Chapters, in: Aspects of Labor Economics, pages 63-106 National Bureau of Economic Research, Inc. [Downloadable!]
  8. Baily, Martin Neil, 1978. "Some aspects of optimal unemployment insurance," Journal of Public Economics, Elsevier, vol. 10(3), pages 379-402, December. [Downloadable!] (restricted)
  9. Gruber, Jonathan, 1997. "The Consumption Smoothing Benefits of Unemployment Insurance," American Economic Review, American Economic Association, vol. 87(1), pages 192-205, March. [Downloadable!] (restricted)
  10. Davidson, Carl & Woodbury, Stephen A., 1997. "Optimal unemployment insurance," Journal of Public Economics, Elsevier, vol. 64(3), pages 359-387, June. [Downloadable!] (restricted)
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  11. Daron Acemoglu & Robert Shimer, 1999. "Efficient Unemployment Insurance," Journal of Political Economy, University of Chicago Press, vol. 107(5), pages 893-928, October. [Downloadable!] (restricted)
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  12. Mikhail Golosov & Aleh Tsyvinski, 2006. "Optimal Taxation with Endogenous Insurance Markets," Levine's Bibliography 784828000000000445, UCLA Department of Economics. [Downloadable!]
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  13. Topel, Robert H, 1983. "On Layoffs and Unemployment Insurance," American Economic Review, American Economic Association, vol. 73(4), pages 541-59, September. [Downloadable!] (restricted)
  14. Martin Feldstein & James M. Poterba, 1984. "Unemployment Insurance and Reservation Wages," NBER Working Papers 1011, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  15. Cullen, Julie Berry & Gruber, Jonathan, 2000. "Does Unemployment Insurance Crowd Out Spousal Labor Supply?," Journal of Labor Economics, University of Chicago Press, vol. 18(3), pages 546-72, July. [Downloadable!] (restricted)
  16. Jonathan Gruber, 1994. "The Consumption Smoothing Benefits of Unemployment Insurance," NBER Working Papers 4750, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  17. Saez, Emmanuel, 2001. "Using Elasticities to Derive Optimal Income Tax Rates," Review of Economic Studies, Blackwell Publishing, vol. 68(1), pages 205-29, January.
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  18. James Costain, 1997. "Unemployment Insurance with Endogenous Search Intensity and Precautionary Saving," Economics Working Papers 243, Department of Economics and Business, Universitat Pompeu Fabra. [Downloadable!]
  19. Martin Browning & Thomas Crossley, 1999. "Unemployment Insurance Benefit Levels and Consumption Changes," CEPR Discussion Papers 405, Centre for Economic Policy Research, Research School of Social Sciences, Australian National University. [Downloadable!]
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  20. Hopenhayn, Hugo A & Nicolini, Juan Pablo, 1997. "Optimal Unemployment Insurance," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 412-38, April.
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Raj Chetty & Emmanuel Saez, 2008. "Optimal Taxation and Social Insurance with Endogenous Private Insurance," NBER Working Papers 14403, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Christian Keuschnigg, 2008. "Corporate Taxation and the Welfare State," Working Papers 0813, Oxford University Centre for Business Taxation. [Downloadable!]
    Other versions:
  3. Raj Chetty & Adam Looney, 2005. "Consumption Smoothing and the Welfare Consequences of Social Insurance in Developing Economies," NBER Working Papers 11709, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  4. Christian Keuschnigg & Evelyn Ribi, 2007. "Outsourcing, Unemployment and Welfare Policy," University of St. Gallen Department of Economics working paper series 2007 2007-41, Department of Economics, University of St. Gallen. [Downloadable!]
    Other versions:
  5. Robert Shimer & Iván Werning, 2006. "On the Optimal Timing of Benefits with Heterogeneous Workers and Human Capital Depreciation," NBER Working Papers 12230, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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