DP3043 Unemployment versus In-work Benefits with Search Unemployment and Observable Abilities

Author(s): Jan Boone, A Lans Bovenberg
Publication Date: November 2001
Keyword(s): in-work tax benefits, search, unemployment compensation
JEL(s): H21, J64, J65
Programme Areas: Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3043

This Paper explores the optimal interaction between the tax system and unemployment compensation in insuring people against the risks of involuntary unemployment and low ability. To that end, we introduce search unemployment in a model of optimal non-linear income taxation. We find that the optimal search subsidy (i.e. the difference between the in-work benefit and the unemployment benefit) increases if, for efficient agents, the participation constraint (governing job search) becomes relatively more important than the incentive compatibility constraint (determining hours worked). The relation between unemployment benefits and the optimal level of in-work benefits (the number of people exerting positive work effort) is U (inversely U) shaped.