Unemployment Insurance and Experience Rating: Insurance Versus Efficiency
25 Pages Posted: 2 Feb 2005
Date Written: October 2004
Unemployment insurance (UI) distorts firms' layoff decisions by reducing the cost of laying off workers. To dampen this increase, it has been suggested that UI should be financed with an experience-rated tax. Despite the fact that increasing the level of experience rating can reduce unemployment, it can reduce the insurance coverage workers receive. With high experience rating, firms may reduce their severance payments by more than the UI benefit. We build a model where competitive firms offer contracts with severance payments to risk-averse workers. Frictions in the labor market lead incomplete insurance. This paper shows that less than full experience rating enables the government to increase the insurance coverage workers receive. Welfare implications are also investigated.
Keywords: Unemployment insurance, experience rating, layoffs
JEL Classification: J65, J41
Suggested Citation: Suggested Citation