A common finding of the optimal unemployment insurance (UI) literature is that the optimal replacement rate is around 50 percent; however, a key assumption is that UI is the only government spending activity. I show that optimal UI levels may be dramatically reduced when UI is a small part of overall spending: the negative impact of UI on income tax revenues implies added welfare costs, a mechanism that I call a fiscal externality. Using both a standard calibrated structural job search model and a "sufficient statistics" method, I find that the optimal replacement rate is zero when fiscal externalities are incorporated.
"Fiscal Externalities and Optimal Unemployment Insurance."
American Economic Journal: Economic Policy,
Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
Personal Income and Other Nonbusiness Taxes and Subsidies; includes inheritance and gift taxes
Unemployment: Models, Duration, Incidence, and Job Search
Unemployment Insurance; Severance Pay; Plant Closings