DP8025 Incentive and Insurance Effects of Tax Financed Unemployment Insurance

Author(s): Torben M Andersen
Publication Date: September 2010
Keyword(s): incentives, risk sharing, Search, unemployment benefits
JEL(s): D80, J20, J65
Programme Areas: Labour Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8025

The potential distortions of job-search incentives caused by unemployment benefits and their financing are well known. However, a benefit-tax scheme also provides insurance having direct utility effects as well as indirect effects on risk taking. The latter mitigates or may even dominate standard incentive effects to produce a non-monotone relation between efficiency (incentives) and equity (insurance). This implies that an increase in both benefits and the tax rate up to some point may increase average income and reduce inequality, i.e., there is not necessarily a trade-off between considerations for efficiency and equity. However, optimal utilitarian policies always position the economy at a point where marginal policy changes involve a trade-off, otherwise policies would not be optimal.