Public Economics Program Meeting

April 7 and 8, 2011
Julie Cullen and Amy Finkelstein, Organizers

Johannes Schmieder, Boston University; Till M. von Wachter, Columbia University and NBER; and Stefan Bender, Institut fur Abreitsmartk - und Berufsforschung
The Effects of Extended Unemployment Insurance Over the Business Cycle: Evidence from Regression Discontinuity Estimates over Twenty Years

A common policy in the United States is to increase the duration of unemployment insurance (UI) benefits in recessions. Theory suggests that the optimal duration of the extension should depend on the exhaustion rate of benefits and on the size of the effect of UI benefits on non-employment, but because benefit duration in the United States varies with the business cycle, it is difficult to estimate those relationships. Schmieder, von Wachter, and Bender exploit the fact that in Germany the duration of UI benefits is a function of exact age, which does not vary over the cycle. Using the universe of unemployment spells and career histories, the authors employ a regression discontinuity strategy separately for twenty years and across industries and correlate their estimates with measures of the business cycle. They find that the non-employment effects of UI extensions decline somewhat in large recessions. Still, the UI exhaustion rate, and therefore the additional coverage provided by UI extensions, rises substantially during a downturn. The authors derive a new welfare formula in a model of job search with liquidity constraints that links the net social benefits from UI extensions to the exhaustion rate and the disincentive effect of UI. Overall, their empirical findings imply that the optimal UI benefit duration rises with the exhaustion rate.

Kory Kroft, Yale University, and Matthew J. Notowidigdo, MIT
Should Unemployment Insurance Vary With the Unemployment Rate? Theory and Evidence

Kroft and Notowidigdo study how optimal unemployment insurance (UI) benefits vary over the business cycle. Theoretically, they characterize how the moral hazard cost and the consumption smoothing benefits of UI vary over the business cycle in a standard job search model. This analysis motivates their empirical strategy, which tests whether the effect of UI on unemployment durations and the consumption drop at unemployment vary with the unemployment rate. In the preferred specifiĀ…cation, a one standard deviation increase in the state unemployment rate reduces the magnitude of the duration elasticity by 42 percent. By contrast, using consumption changes upon unemployment, there is no evidence that the consumption smoothing benefit of UI varies with the unemployment rate. Combining these empirical estimates to calibrate the optimal level of UI benefits implied by the model, they find that a one standard deviation increase in the unemployment rate leads to a 9 to 17 percentage point increase in the optimal replacement rate.

Camille Landais, Stanford University; Pascal Michaillat, London School of Econimics; and Emmanuel Saez, University of California at Berkeley and NBER
Optimal Unemployment Insurance over the Business Cycle

Landais, Michaillat, and Saez characterize optimal unemployment insurance over the business cycle in a model in which unemployment stems from matching frictions (in booms) and job rationing (in recessions). Job rationing introduces two effects not captured by previous studies. First, job-search efforts have little effect on aggregate unemployment because the number of jobs available is limited, independent of search and matching. Second, while job-search efforts increase the individual probability of finding a job, they create a negative externality by reducing other jobseekers' probability of finding one of the few available jobs. Both effects are captured by the positive and countercyclical wedge between micro-elasticity and macro-elasticity of unemployment with respect to net reward from work. The authors derive a simple optimal unemployment insurance formula expressed in terms of those two elasticities and risk aversion. The formula coincides with the classical Baily-Chetty formula only when unemployment is low, and macro- and micro-elasticity are (almost) equal. The formula implies that the generosity of unemployment insurance should be countercyclical. The authors illustrate this result by simulating optimal unemployment insurance over the business cycle in a dynamic stochastic general equilibrium model calibrated with U.S. data.

Christina D. Romer and David H. Romer, University of California at Berkeley and NBER
The Effects of Marginal Tax Rates: Evidence from the Interwar Era

Romer and Romer use the interwar period in the United States as a laboratory for investigating the incentive effects of changes in marginal income tax rates. Marginal rates changed frequently and drastically in the 1920s and 1930s, and the changes varied greatly across income groups at the top of the income distribution. The authors examine the effect of these changes on taxable income using time-series/cross-section analysis of data on income and taxes by small slices of the income distribution. They find that the elasticity of taxable income to changes in the log aftertax share (one minus the marginal rate) is positive but very small (approximately 0.2) and precisely estimated (a t-statistic over 6). The estimate is highly robust. They also examine the time-series response of available indicators of investment and entrepreneurial activity to changes in marginal rates. They find little evidence of an important relationship, suggesting that the long-run productivity effects of changes in marginal rates may also be small.

Patrick M. Kline, University of California at Berkeley and NBER; Matias Busso, Inter-American Development Bank; and Jesse Gregory, University of Michigan
Assessing the Incidence and Efficiency of a Prominent Place Based Policy

Kline, Busso, and Gregory empirically assess the incidence and efficiency of Round I of the federal urban Empowerment Zone (EZ) program using confidential microdata from the Decennial Census and the Longitudinal Business Database. Using rejected and future applicants to the EZ program as controls, they find that EZ designation substantially increased employment in zone neighborhoods and generated wage increases for local workers without corresponding increases in population or the local cost of living. The results suggest that the efficiency costs of first Round EZs were relatively small.

Kathleen Mullen and Nicole Maestas, RAND Corporation, and Alexander Strand, Social Security Administration
Does Disability Insurance Receipt Discourage Work? Using Examiner Assignment to Estimate Causal Effects of SSDI Receipt

Mullen, Strand, and Maestas present the first estimates of the causal effects of Social Security Disability Insurance receipt on labor supply that are estimated using the entire population of program applicants. The researchers exploit administrative data to match applications to disability examiners, and use natural variation in examiners' allowance rates as an instrument for the allowance decision in a labor supply equation, contrasting denied versus allowed applicants. Importantly, they find that the disincentive effect is heterogeneous, ranging from a 10 percentage point reduction in labor force participation for those with more severe impairments to a 60 percentage point reduction for entrants with relatively less severe impairments.

Lex Borghans, Maastricht University; Anne Gielen, IZA; and Erzo F.P. Luttmer, Dartmouth College and NBER
Social Support Shopping: Evidence from a Regression Discontinuity in Disability Insurance Reform

Borghans, Gielen, and Luttmer examine how a change in the generosity of one social assistance program generates spillovers onto other social assistance programs. They exploit an age discontinuity in the stringency of the 1993 Dutch disability reforms to estimate the effect of decreases in the generosity of disability insurance (DI) on reliance on other forms of social assistance. They find strong evidence of "social support shopping": for each Euro saved in DI benefits, the government has to spend an extra 51 cents in other social assistance programs. This benefit-shifting ratio is even larger if they also take into account the response of the partners' of those affected by the DI reform. The benefit shifting effect declines over time, but is still 21 percent eight years after the reform. In addition, they find a substantial degree of crowd out of labor income by disability benefits. For each Euro in lost DI benefits, individuals on average increase their earnings by 95 cents.

Liran Einav and Mark R. Cullen, Stanford University and NBER; Amy Finkelstein and Stephen P. Ryan, MIT and NBER; and Paul Schrimpf, MIT
Selection on Moral Hazard in Health Insurance

Einav, Finkelstein, Ryan, Schrimpf, and Cullen explore the possibility that individuals may select insurance coverage in part based on their anticipated behavioral response to the insurance contract. Such "selection on moral hazard" can have important implications for attempts to combat either selection or moral hazard. The authors explore these issues using individual-level panel data from a single firm, which contain information about health insurance options, choices, and subsequent claims. To identify the behavioral response to health insurance coverage and the heterogeneity in it, they take advantage of a change in the health insurance options offered to some, but not all of the firm's employees. They begin with descriptive evidence that is suggestive of both heterogeneous moral hazard and selection on it, with individuals who select more coverage also appearing to exhibit greater behavioral response to that coverage. To formalize this analysis and explore its implications, they develop and estimate a model of plan choice and medical utilization. The results from the modeling exercise echo the descriptive evidence, and allow for further explorations of the interaction between selection and moral hazard. For example, one implication of our estimates is that abstracting from selection on moral hazard could lead one to substantially over-estimate the spending reduction associated with introducing a high deductible health insurance option.

Paul Niehaus, University of California, San Diego, and Sandip Sukhtankar, Dartmouth College
The Marginal Rate of Corruption in Public Program

The marginal benefits of public spending are a key determinant of optimal fiscal policy, yet in developing countries public funds often are stolen by corrupt officials. Niehaus and Sukhtankar provide the first theoretical and empirical analyses of marginal corruption, analyzing the effects of a large statutory wage increase in India's national employment scheme. Strikingly, none of that increase was passed through to workers even though initially most were, if anything, overpaid. The theory and supporting evidence suggest this is because it is the threat of exit to the private sector, not the threat of complaints, that is the workers' main source of bargaining power. Officials effectively price program jobs to market, consistent with the "greasing the wheels" view of corruption.

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