Make work pay or make search pay? Redistributive taxation and unemployment insurance

Résumé

This paper studies the interactions between redistribution and social insurance in a general framework that nests two cornerstones of public economics: the Mirrlees-Saez optimal income taxation model and the Baily-Chetty optimal unemployment insurance model. Heterogeneous agents make endogenous labor supply decisions given their earnings ability on the job and their fixed costs of participation to the labor market. They are further exposed to unemployment risk on the labor market and must provide costly job search efforts if they become unemployed. In this environment, I characterize the optimal tax-benefits schedule using both mechanism design and perturbation methods. Results show that: (1) Unemployment risk mechanically dampens the disincentive effect of taxation and calls for higher tax rates. (2) The need for job search incentives magnifies the disincentive effect of taxation and calls for lower tax rates to “make search pay”. (3) Redistributive concerns call for progressivity in the unemployment benefits scheme. (4) The need for work incentives reduces the disincentive effect of unemployment insurance and calls for higher replacement rates to “make work pay”. Overall, the analysis reveals that optimal redistribution and unemployment insurance problems interact, and that these interactions have important policy implications.