Welfare States and Unemployment

Lars Ljungqvist and Thomas Sargent

Economic Theory, 1995, vol. 6, issue 1, 143-60

Abstract: This paper studies equilibrium unemployment in a search model where the government both provides liberal unemployment insurance and taxes labor at high progressive tax rates. It is shown how progressive income taxation can counteract a high unemployment rate under generous unemployment insurance. In particular, high marginal taxes reduce workers' incentives to switch jobs in response to changing economic opportunities. This lower labor mobility reduces unemployment but at the cost of a less efficient labor allocation.

Date: 1995
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