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Title: Firing Tax and Severance Payment in Search Economies: A Comparison

Author(s): Pietro Garibaldi and Giovanni L. Violante

Publication Date: November 2002

Keyword(s): firing tax, severance payment, unemployment and wage rigidity

Programme Area(s): Labour Economics

Abstract: Employment Protection rules have two separate dimensions: a transfer from the firm to the worker to be laid off and a tax paid outside the firm-worker pair. It is well established that with full wage flexibility statutory severance payments (pure transfers) between employers and dismissed employees are neutral (Lazear 1988, 1990). Most of the existing literature makes the implicit assumption that, in the presence of wage rigidity, such mandatory transfers have the same real effects as firing taxes. This Paper shows, in the context of a search model, that this presumption is in general misplaced. It is only correct in the case of extreme wage rigidity, whereas when some (but not full) flexibility in the wage setting at the level of an individual employer-worker match is allowed, the impact of severance payments on unemployment duration and incidence is qualitatively different from that of firing taxes (and its sign depends on the nature of the wage rigidity).

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Bibliographic Reference

Garibaldi, P and Violante, G. 2002. 'Firing Tax and Severance Payment in Search Economies: A Comparison'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=3636