Sick Pay Policies and the Socioeconomic Gradient in Health and Welfare

Sick pay compensates for income loss during illness. However, it may distort labor supply by affecting gross wages if paid by employers and net wages if financed by social insurance contributions. We develop a dynamic general equilibrium model with endogenous, biologically founded health and aging in an education-stratified society to study how the level and financing of sick pay affect the socioeconomic health gradient, income inequality, life expectancy, and welfare. Our analysis shows that reducing the sick pay replacement rate would significantly raise distributional disparities in income and health in Germany. We also show that the individually preferred sick pay replacement rate decreases with the level of educational attainment and that most individuals prefer employer-funded sick pay over public financing.