Working Paper: NBER ID: w10500
Authors: Raj Chetty
Abstract: Studies of the consumption-smoothing benefits of unemployment insurance (UI) have found that the optimal benefit level is very small, perhaps even 0, for conventional levels of risk aversion. In this paper, I derive a formula for the optimal benefit rate in terms of income and price elasticities of unemployment durations, directly inferring risk aversion for the unemployed from their behavioral responses to UI benefits. The optimal rate of social insurance is shown to depend positively on the size of the income elasticity and negatively on the size of the substitution elasticity. I estimate these elasticities using semi-parametric hazard models and variation in UI laws across states and over time. The estimates indicate that income effects account for 70% of the effect of UI on unemployment durations, and yield an optimal replacement rate around 50% of pre-unemployment wages. These results challenge the prevailing view that social safety nets provide minimal welfare gains at a large efficiency cost.
Keywords: Unemployment Insurance; Income Effects; Optimal Benefit Level
JEL Codes: C41; D8; E24; H5; J6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Variation in unemployment insurance laws (J65) | Income and price elasticities of unemployment durations (J64) |
| Unemployment insurance benefits (J65) | Labor supply and search behavior among unemployed individuals (J29) |
| Income effects (H31) | Optimal benefit level (D61) |
| Income effects (H31) | Unemployment durations (J64) |
| Small lump-sum grants (H81) | Exit rates from unemployment (J65) |
| Unemployment insurance system (J65) | Consumption-smoothing benefits (D15) |