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Work Incentive Effects of Taxing Unemployment Benefits

  • Gary Solon

Before 1979, unemployment insurance (UI) benefits were not treated as taxable income in the United States. Several economists criticized this policy on the ground that not taxing UI benefits while taxing earned income allegedly encourages unemployed persons to conduct longer than socially optimal job searches. Since 1979, however, UI benefits received by persons in higher-income families have been subject to income tax. This paper investigates whether the introduction of benefit taxation has had the predicted effect of reducing unemployment duration.The study uses data on a sample of persons that filed for UI in 1978 or 1979 to examine whether high-income claimants collected benefits fo rshorter periods after the tax change than they did before benefits became taxable. As part of the empirical analysis, the paper develops a generalization of the Weibull distribution and applies a limited-dependent-variable technique for this distribution similar to the Tobit technique for the normal distribution. Despite some variation in the results from different model specifications, the analysis presents persuasive evidence of a tax effect on unemployment duration. The 1979 policy change is estimated to have reduced average compensated unemployment duration among the sampled high-income claimants by about one week.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1260.

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Date of creation: Jan 1984
Date of revision:
Publication status: published as Solon, Gary. "Work Incentive Effects of Taxing Unemployment Benefits," Econometrica, Vol. 53, No. 2, March 1985, pp. 295-306.
Handle: RePEc:nbr:nberwo:1260
Note: LS
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  1. Lippman, Steven A & McCall, John J, 1976. "The Economics of Job Search: A Survey," Economic Inquiry, Western Economic Association International, vol. 14(3), pages 347-68, September.
  2. Nickell, Stephen J, 1979. "Estimating the Probability of Leaving Unemployment," Econometrica, Econometric Society, vol. 47(5), pages 1249-66, September.
  3. Moffitt, Robert & Nicholson, Walter, 1982. "The Effect of Unemployment Insurance on Unemployment: The Case of Federal Supplemental Benefits," The Review of Economics and Statistics, MIT Press, vol. 64(1), pages 1-11, February.
  4. Rosen, Harvey S, 1976. "Taxes in a Labor Supply Model with Joint Wage-Hours Determination," Econometrica, Econometric Society, vol. 44(3), pages 485-507, May.
  5. Ehrenberg, Ronald G & Oaxaca, Ronald L, 1976. "Unemployment Insurance, Duration of Unemployment, and Subsequent Wage Gain," American Economic Review, American Economic Association, vol. 66(5), pages 754-66, December.
  6. Lancaster, Tony, 1979. "Econometric Methods for the Duration of Unemployment," Econometrica, Econometric Society, vol. 47(4), pages 939-56, July.
  7. Arlene Holen, 1977. "Effects of unemployment insurance entitlement on duration and job search outcome," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 30(4), pages 445-450, July.
  8. Mortensen, Dale T, 1970. "Job Search, the Duration of Unemployment, and the Phillips Curve," American Economic Review, American Economic Association, vol. 60(5), pages 847-62, December.
  9. Heckman, James J & Borjas, George J, 1980. "Does Unemployment Cause Future Unemployment? Definitions, Questions and Answers from a Continuous Time Model of Heterogeneity and State Dependence," Economica, London School of Economics and Political Science, vol. 47(187), pages 247-83, August.
  10. Finis Welch, 1977. "What have we learned from empirical studies of unemployment insurance?," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 30(4), pages 451-461, July.
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