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Unemployment benefits or taxes: How should policy makers redistribute income over the business cycle?

  • Ek, Susanne

    ()

    (Department of Economics)

This paper studies optimal unemployment bene…fit levels and optimal proportional income tax rates over the business cycle. Previous research suggests that policy makers should make unemployment insurance (UI) dependent on the business cycle because the UI system can be used to smooth consumption across different economic states. However, high bene…fits increase unemployment. An alternative way to redistribute income is to vary tax rates over the business cycle. In this paper, we develop an equilibrium search and matching model with risk-averse workers and two states, namely, a good and a bad state. The model yields potential ambiguity concerning the welfare effects of business cycle-dependent UI. The model is calibrated to United States (U.S.) labor market data. The numerical results suggest that higher benefi…ts in the bad state are optimal, but the benefi…t differential is small. A more e¢ cient way for policy makers to redistribute income over the business cycle is to decrease taxes in the bad state. Compared to an optimal uniform system, however, di¤erentiation yields small welfare gains. Nevertheless, imposing two tax rates strictly dominates imposing two bene…t levels. This fi…nding is robust to a wide range of sensitivity checks.

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File URL: http://uu.diva-portal.org/smash/get/diva2:490905/FULLTEXT01.pdf
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Paper provided by Uppsala University, Department of Economics in its series Working Paper Series with number 2012:2.

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Length: 30 pages
Date of creation: 20 Jan 2012
Date of revision:
Handle: RePEc:hhs:uunewp:2012_002
Contact details of provider: Postal: Department of Economics, Uppsala University, P. O. Box 513, SE-751 20 Uppsala, Sweden
Phone: + 46 18 471 25 00
Fax: + 46 18 471 14 78
Web page: http://www.nek.uu.se/
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  1. Pascal Michaillat & Emmanuel Saez & Camille Landais, 2011. "Optimal Unemployment Insurance over the Business Cycle," 2011 Meeting Papers 124, Society for Economic Dynamics.
  2. Stanislav Rabinovich & Kurt Mitman, 2011. "Pro-cyclical Unemployment Benefits? Optimal Policy in an Equilibrium Business Cycle Model," 2011 Meeting Papers 1247, Society for Economic Dynamics.
  3. Michael Kiley, 2002. "How Should Unemployment Benefits Respond to the Business Cycle?," Computing in Economics and Finance 2002 167, Society for Computational Economics.
  4. Pierre Cahuc & André Zylberberg, 2004. "Labor Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 026203316x, June.
  5. Camille Landais & Pascal Michaillat & Emmanuel Saez, 2010. "A Macroeconomic Theory of Optimal Unemployment Insurance," NBER Working Papers 16526, National Bureau of Economic Research, Inc.
  6. Torben M. Andersen & Michael Svarer, 2011. "State Dependent Unemployment Benefits," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 78(2), pages 325-344, 06.
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