DP7984 Payroll Taxes, Social Insurance and Business Cycles

Author(s): Michael C Burda, Mark Weder
Publication Date: September 2010
Keyword(s): Business cycles, consumption-tightness puzzle, labor markets, payroll taxes, unemployment
JEL(s): E24, E32, J64
Programme Areas: Labour Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=7984

Payroll taxes represent a major distortionary influence of governments on labor markets. This paper examines the role of payroll taxation and the social safety net for cyclical fluctuations in a nonmonetary economy with labor market frictions and unemployment insurance, when the latter is only imperfectly related to search eff ort. A balanced social insurance budget renders gross wages more rigid over the cycle and, as a result, strengthens the model’s endogenous propagation mechanism. For conventional calibrations, the model generates a negatively sloped Beveridge curve as well as substantial volatility and persistence of vacancies and unemployment.