Working Paper: CEPR ID: DP3636
Authors: Pietro Garibaldi; Giovanni L. Violante
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).
Keywords: Firing Tax; Severance Payment; Unemployment; Wage Rigidity
JEL Codes: E24; J64; J65
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| severance payments (J65) | unemployment duration (J64) |
| severance payments (J65) | unemployment incidence (J64) |
| wage rigidity (J31) | effects of severance payments (J65) |
| full wage flexibility (J31) | severance payments neutral on unemployment rates (J65) |
| wage rigidity binds at entry (J31) | reduced job creation (J68) |
| wage rigidity binds at entry (J31) | increased unemployment duration (J64) |
| wage rigidity binds at exit (J63) | delayed separations (J12) |
| wage rigidity binds at exit (J63) | increased job creation (J68) |
| extreme wage rigidity (J31) | severance payments and firing taxes yield identical effects (J65) |