Unemployment Insurance Fraud and Optimal Monitoring

We present evidence that fraudulent collection of unemployment benefits by workers who are gainfully employed is the most relevant incentive problem for the design of unemployment insurance. We show how to efficiently use a combination of tax/subsidy and monitoring to prevent such fraud. The optimal policy monitors the unemployed at fixed intervals. Employment tax is nonmonotonic: it increases between verifications but decreases after a verification. Unemployment benefits are relatively flat between verifications but decrease sharply after a verification. Our preliminary quantitative analysis indicates that the present value of auditing costs are less than 50% of the cost in the current U.S. system. For the average worker, the optimal contract can deliver the same utility as the U.S. system at less than 1/4 the cost.