IDEAS home Printed from https://ideas.repec.org/p/fip/fedcwq/103754.html

Carrots or Sticks? Short-Time Work vs. Layoff Taxes

Author

Listed:

Abstract

While unemployment insurance systems are widely used to insure workers against income losses after separations, it is well known that they can inefficiently increase separations in the labor market. There are two distinct policy instruments commonly used by governments that can counter this known problem: layoff taxes and short-time work schemes. This study provides a search-and-matching model to evaluate which of the two is the better policy tool. We show that if only a few firms are financially constrained, layoff taxes are better because they do not distort working hours in the economy. With a large share of financially constrained firms, short-time work emerges as the superior tool, as layoff taxes cannot deter separations in financially constrained firms. Additionally, short-time work can help provide insurance against income losses to risk-averse workers that constrained firms cannot afford to provide in their wage contracts. Calibrating the model to the US economy, we find that short-time work is the superior policy instrument if at least 27.5 percent of firms in the economy are financially constrained. Finally, we show that combining both instruments can dominate either policy in isolation when sufficiently many firms of both types are present in the economy.

Suggested Citation

  • Gero Stiepelmann & Johannes Weber, 2026. "Carrots or Sticks? Short-Time Work vs. Layoff Taxes," Working Papers 26-20, Federal Reserve Bank of Cleveland.
  • Handle: RePEc:fip:fedcwq:103754
    DOI: 10.26509/frbc-wp-202620
    as

    Download full text from publisher

    File URL: https://www.clevelandfed.org/-/media/project/clevelandfedtenant/clevelandfedsite/publications/working-papers/2026/wp2620.pdf
    File Function: Full text
    Download Restriction: no

    File URL: https://libkey.io/10.26509/frbc-wp-202620?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Eleni Iliopulos & François Langot & Thepthida Sopraseuth, 2019. "Welfare Cost of Fluctuations When Labor Market Search Interacts with Financial Frictions," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 51(8), pages 2207-2237, December.
    2. Pablo Ottonello & Thomas Winberry, 2020. "Financial Heterogeneity and the Investment Channel of Monetary Policy," Econometrica, Econometric Society, vol. 88(6), pages 2473-2502, November.
    3. Pierre Cahuc, 2024. "The Micro and Macro Economics of Short-Time Work," Post-Print hal-05446679, HAL.
    4. Giulia Giupponi & Camille Landais & Alice Lapeyre, 2022. "Should We Insure Workers or Jobs during Recessions?," Journal of Economic Perspectives, American Economic Association, vol. 36(2), pages 29-54, Spring.
    5. Kai Christoffel & Tobias Linzert, 2010. "The Role of Real Wage Rigidity and Labor Market Frictions for Inflation Persistence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(7), pages 1435-1446, October.
    6. Burdett, Kenneth & Wright, Randall, 1989. "Unemployment Insurance and Short-Time Compensation: The Effects on Layoffs, Hours per Worker, and Wages," Journal of Political Economy, University of Chicago Press, vol. 97(6), pages 1479-1496, December.
    7. Kory Kroft & Matthew J. Notowidigdo, 2016. "Should Unemployment Insurance Vary with the Unemployment Rate? Theory and Evidence," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 83(3), pages 1092-1124.
    8. Pierre Cahuc, 2024. "The Micro and Macro Economics of Short-Time Work," Sciences Po Economics Publications (main) hal-04673743, HAL.
    9. Giulia Giupponi & Camille Landais, 2023. "Subsidizing Labour Hoarding in Recessions: The Employment and Welfare Effects of Short-time Work," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 90(4), pages 1963-2005.
    10. Christopher A. Pissarides & Barbara Petrongolo, 2001. "Looking into the Black Box: A Survey of the Matching Function," Journal of Economic Literature, American Economic Association, vol. 39(2), pages 390-431, June.
    11. David Domeij & Martin Floden, 2006. "The Labor-Supply Elasticity and Borrowing Constraints: Why Estimates are Biased," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(2), pages 242-262, April.
    12. Baily, Martin Neil, 1978. "Some aspects of optimal unemployment insurance," Journal of Public Economics, Elsevier, vol. 10(3), pages 379-402, December.
    13. Schlingemann, Frederik P. & Stulz, René M., 2022. "Have exchange-listed firms become less important for the economy?," Journal of Financial Economics, Elsevier, vol. 143(2), pages 927-958.
    14. Charles J. Hadlock & Joshua R. Pierce, 2010. "New Evidence on Measuring Financial Constraints: Moving Beyond the KZ Index," The Review of Financial Studies, Society for Financial Studies, vol. 23(5), pages 1909-1940.
    15. Pawel Krolikowski & Anna Weixel, 2020. "Short-Time Compensation: An Alternative to Layoffs during COVID-19," Economic Commentary, Federal Reserve Bank of Cleveland, vol. 2020(26), pages 1-6, October.
    16. David Ratner, 2013. "Unemployment Insurance Experience Rating and Labor Market Dynamics," Finance and Economics Discussion Series 2013-86, Board of Governors of the Federal Reserve System (U.S.).
    17. Engen, Eric M. & Gruber, Jonathan, 2001. "Unemployment insurance and precautionary saving," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 545-579, June.
    18. Duygan-Bump, Burcu & Levkov, Alexey & Montoriol-Garriga, Judit, 2015. "Financing constraints and unemployment: Evidence from the Great Recession," Journal of Monetary Economics, Elsevier, vol. 75(C), pages 89-105.
    19. Campello, Murillo & Graham, John R. & Harvey, Campbell R., 2010. "The real effects of financial constraints: Evidence from a financial crisis," Journal of Financial Economics, Elsevier, vol. 97(3), pages 470-487, September.
    20. Cahuc, Pierre, 2024. "The micro and macro economics of short-time work," Handbook of Labor Economics,, Elsevier.
    21. Cahuc, Pierre & Zylberberg, André, 2008. "Optimum income taxation and layoff taxes," Journal of Public Economics, Elsevier, vol. 92(10-11), pages 2003-2019, October.
    22. Chetty, Raj, 2006. "A general formula for the optimal level of social insurance," Journal of Public Economics, Elsevier, vol. 90(10-11), pages 1879-1901, November.
    23. Andrew C. Johnston, 2021. "Unemployment Insurance Taxes and Labor Demand: Quasi-Experimental Evidence from Administrative Data," American Economic Journal: Economic Policy, American Economic Association, vol. 13(1), pages 266-293, February.
    24. Shavell, Steven & Weiss, Laurence, 1979. "The Optimal Payment of Unemployment Insurance Benefits over Time," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1347-1362, December.
    25. Fonseca, Julia & Van Doornik, Bernardus, 2022. "Financial development and labor market outcomes: Evidence from Brazil," Journal of Financial Economics, Elsevier, vol. 143(1), pages 550-568.
    26. Olivier J. Blanchard & Jean Tirole, 2008. "The Joint Design of Unemployment Insurance and Employment Protection: A First Pass," Journal of the European Economic Association, MIT Press, vol. 6(1), pages 45-77, March.
    27. Philip Jung & Keith Kuester, 2015. "Optimal Labor-Market Policy in Recessions," American Economic Journal: Macroeconomics, American Economic Association, vol. 7(2), pages 124-156, April.
    28. Krause, Michael U. & Lubik, Thomas A., 2007. "The (ir)relevance of real wage rigidity in the New Keynesian model with search frictions," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 706-727, April.
    29. Hopenhayn, Hugo A & Nicolini, Juan Pablo, 1997. "Optimal Unemployment Insurance," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 412-438, April.
    30. Kirk White & Arpad Abraham, 2004. "The Dynamics of Plant-level Productivity in U.S. Manufacturing," Computing in Economics and Finance 2004 332, Society for Computational Economics.
    31. Dale T. Mortensen & Christopher A. Pissarides, 1994. "Job Creation and Job Destruction in the Theory of Unemployment," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 61(3), pages 397-415.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Philip Jung & Keith Kuester, 2015. "Optimal Labor-Market Policy in Recessions," American Economic Journal: Macroeconomics, American Economic Association, vol. 7(2), pages 124-156, April.
    2. Michau, Jean-Baptiste, 2015. "Optimal labor market policy with search frictions and risk-averse workers," Labour Economics, Elsevier, vol. 35(C), pages 93-107.
    3. Raj Chetty & Amy Finkelstein, 2012. "Social Insurance: Connecting Theory to Data," NBER Working Papers 18433, National Bureau of Economic Research, Inc.
    4. Cahuc, Pierre, 2024. "The micro and macro economics of short-time work," Handbook of Labor Economics,, Elsevier.
    5. Tito Boeri & Pierre Cahuc, 2022. "Labor Market Insurance Policies in the XXI Century," Post-Print hal-03878719, HAL.
    6. Reichling, Felix, 2006. "Optimal Unemployment Insurance in Labor Market Equilibrium when Workers can Self-Insure," MPRA Paper 5362, University Library of Munich, Germany, revised 16 Oct 2007.
    7. Mitman, Kurt & Rabinovich, Stanislav, 2021. "Whether, when and how to extend unemployment benefits: Theory and application to COVID-19," Journal of Public Economics, Elsevier, vol. 200(C).
    8. Christoffel, Kai & Kuester, Keith, 2008. "Resuscitating the wage channel in models with unemployment fluctuations," Journal of Monetary Economics, Elsevier, vol. 55(5), pages 865-887, July.
    9. Albert Jan Hummel, 2021. "Unemployment and tax design," Tinbergen Institute Discussion Papers 21-061/VI, Tinbergen Institute.
    10. Saez, Emmanuel & Landais, Camille & Michaillat, Pascal, 2010. "Optimal Unemployment Insurance over the Business Cycle," CEPR Discussion Papers 8132, Centre for Economic Policy Research.
    11. Johannes F. Schmieder & Till von Wachter, 2016. "The Effects of Unemployment Insurance Benefits: New Evidence and Interpretation," Annual Review of Economics, Annual Reviews, vol. 8(1), pages 547-581, October.
    12. Serdar Birinci & Kurt Gerrard See, 2018. "How Should Unemployment Insurance vary over the Business Cycle?," 2018 Meeting Papers 69, Society for Economic Dynamics.
    13. Albertini, Julien & Fairise, Xavier & Terriau, Anthony, 2023. "Unemployment insurance, recalls, and experience rating," Journal of Macroeconomics, Elsevier, vol. 75(C).
    14. Hassler, John & Rodríguez Mora, José V., 2008. "Unemployment insurance design: Inducing moving and retraining," European Economic Review, Elsevier, vol. 52(5), pages 757-791, July.
    15. Cahuc, Pierre, 2014. "Search, flows, job creations and destructions," Labour Economics, Elsevier, vol. 30(C), pages 22-29.
    16. Diwambuena, Josué & Fonseca, Raquel & Schubert, Stefan, 2025. "Labor market institutions, productivity, and the business cycle: An application to Italy," European Economic Review, Elsevier, vol. 178(C).
    17. Demirgüç-Kunt, Asli & Lokshin, Michael & Torre, Iván, 2024. "Protect incomes or protect jobs? The role of social policies in post-pandemic recovery," World Development, Elsevier, vol. 182(C).
    18. Camille Landais & Pascal Michaillat & Emmanuel Saez, 2010. "A Macroeconomic Theory of Optimal Unemployment Insurance," NBER Working Papers 16526, National Bureau of Economic Research, Inc.
    19. Walter Nicholson & Karen Needels, "undated". "The EUC08 Program in Theoretical and Historical Perspective," Mathematica Policy Research Reports 9046cb11c3aa44c8a036a6e38, Mathematica Policy Research.
    20. Kjell Erik Lommerud & Odd Rune Straume & Steinar Vagstad, 2018. "Employment Protection and Unemployment Benefits: On Technology Adoption and Job Creation in a Matching Model," Scandinavian Journal of Economics, Wiley Blackwell, vol. 120(3), pages 763-793, July.

    More about this item

    Keywords

    ;
    ;
    ;
    ;
    ;

    JEL classification:

    • J63 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Turnover; Vacancies; Layoffs
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search
    • J65 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment Insurance; Severance Pay; Plant Closings
    • J68 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Public Policy

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fedcwq:103754. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: 4D Library (email available below). General contact details of provider: https://edirc.repec.org/data/frbclus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.