Labor supply effects of social insurance
chapter 33 of Handbook of Public Economics, Volume 4, 2002, Pages 2327-2392
BibTeX
@article{krueger2002labor,
title={Labor supply effects of social insurance},
author={Krueger, Alan B and Meyer, Bruce D},
journal={Handbook of public economics},
volume={4},
pages={2327--2392},
year={2002},
publisher={Elsevier}
}
Abstract
This chapter examines the labor supply effects of social insurance programs. We argue that this topic deserves separate treatment from the rest of the labor supply literature because individuals may be imperfectly informed as to the rules of the programs and because key parameters are likely to differ for those who are eligible for social insurance programs, such as the disabled. Furthermore, differences in social insurance programs often provide natural experiments with exogenous changes in wages or incomes that can be used to estimate labor supply responses. Finally, social insurance often affects different margins of labor supply. For example, the labor supply literature deals mostly with adjustments in the number of hours worked, whereas the incentives of social insurance programs frequently affect the decision of whether to work at all.
The empirical work on unemployment insurance (UI) and workers’ compensation (WC) insurance finds that the programs tend to increase the length of time employees spend out of work. Most of the estimates of the elasticities of lost work time that incorporate both the incidence and duration of claims are close to 1.0 for unemployment insurance and between 0.5 and 1.0 for workers’ compensation. These elasticities are substantially larger than the labor supply elasticities typically found for men in studies of the effects of wages or taxes on hours of work. The evidence on disability insurance and (especially) social security retirement suggests much smaller and less conclusively established labor supply effects. Part of the explanation for this difference probably lies in the fact that UI and WC lead to short-run variation in wages with mostly a substitution effect. Our review suggests that it would be misleading to apply a universal set of labor supply elasticities to these diverse problems and populations.
Notes and Excerpts
Approximately 97% of all wage and salary workers are in jobs that are covered by unemployment insurance. The main categories of workers not covered are the selfemployed, employees of small farms, and household employees whose earnings are below the threshold amount. Despite this near universal coverage, less than forty percent of the unemployed received UI in many recent years7 . The cause of this low rate of receipt is largely that individuals who are new entrants or reentrants to the labor force, who have irregular work histories, and individuals who quit or are fired from their last job are typically not eligible for benefits.
About 35% of claimants receive the maximum benefit. For these individuals, the fraction of their previous earnings replaced by UI can be much lower than 50%.
A convenient indicator of the work disincentive of UI is the fraction of previous after-tax earnings replaced by after-tax benefits, the after-tax replacement rate. This replacement rate has fallen dramatically in recent years, particularly due to the taxation of benefits, and is now typically under one-half. As recently as 1986, some people had replacement rates near one (often those lifted by the minimum benefit), implying that they would receive from UI nearly what they would earn if they returned to work.12 12 See Feldstein (1974) for an earlier discussion and evidence on high replacement rates
Second, the labor supply elasticities estimated in the labor economics literature span a huge range. Literature surveys such as Pencavel (1986) and Killingsworth (1983) find wide dispersion in estimates of income and substitution effects. Fuchs, Krueger and Poterba (1998) also find that there is little agreement among economists on the magnitude of labor supply elasticities. A major shortcoming in the broader labor supply literature is that it is difficult to identify exogenous changes in wages or income that can be used to estimate labor supply responses.
incomplete experience rating? Need to come back later to try groking that a bit more.
Several of the studies, including Classen (1979), Solon (1985), and Meyer (1990, 1992a), find elasticities of duration with respect to the level of benefits over 0.5. The elasticity estimates with respect to the potential duration (length) of benefits tend to be much lower.
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Overall, the combined effect of benefits on unemployment through incidence and duration is suggested to be near one by these studies. This result is consistent with the aggregate analysis of twenty OECD countries by Nickell (1998) who finds an elasticity of unemployment with respect to the replacement rate of close to one.