Fiscal Externalities and Optimal Unemployment Insurance

No 1357, AMSE Working Papers from Aix-Marseille School of Economics, France

Abstract: A common finding of the optimal unemployment insurance literature is that the optimal UI replacement rate is around 50%, implying that current levels in the US are close to optimal. However, a key assumption in the existing literature is that unemployment benefits are the only government spending activity. In this paper I show that recommendations for optimal UI levels are dramatically reduced when one incorporates the fact that UI spending is a small part of overall government spending. This occurs because the negative impact of UI on income tax revenues implies added welfare costs, a mechanism that I refer to as a fiscal externality. Using both a calibrated structural job search model and a "sufficient statistics" method that relies on reduced-form elasticities, I find that the optimal replacement rate drops to zero once fiscal externalities are incorporated. However, I also consider the possibility that more generous UI could increase reservation wages and thus potentially increase the tax base, and I show that this second fiscal externality could have important effects on the results, with an optimal replacement rate which could rise above 70%.

Keywords: unemployment insurance; fiscal externality; job search; sufficient statistics; government spending (search for similar items in EconPapers)
Pages: 55 pages
Date: 2013-11-21, Revised 2013-11-21
New Economics Papers: this item is included in nep-dge, nep-mac and nep-pbe
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Related works:
Journal Article: Fiscal Externalities and Optimal Unemployment Insurance (2017)
Working Paper: Fiscal Externalities and Optimal Unemployment Insurance (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:aim:wpaimx:1357

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