Ruhr Economic Papers

Ruhr Economic Papers #121

Killing them with Kindness: Negative Distributional Externalities of Increasing UI Benefits

by John P. Haisken-DeNew and Matthias Vorell

RWI, 07/2009, 18 S./p., 8 Euro, ISBN 978-3-86788-135-7



Of the many labour market Hartz~IV reforms that have been implemented in Germany since 2005, the role of short-term unemployment insurance has not received much attention. In this
paper we examine distributional effects of labour earnings and unemployment benefits using simulated increases in unemployment insurance replacement rates or equivalently, increases in the net present value of benefit duration. Starting around an 18%-point increase in the replacement rate, there are significant negative labour supply effects, drawing those employed into unemployment shifting the mass of the earnings distribution to the left. At around a 25%-point increase in the replacement rate, the mass of the distribution shifts right again, as those receiving unemployment benefits simply enjoy an increased transfer. Thus, due to the
substantial negative labour supply effects, German economic policy should avoid potentially increasing the UI benefit replacement rate (or equivalently, increasing the benefit duration) in the near future as a response to the world-wide economic crisis.

JEL-Classification: J65, D31, J22

Keywords: Unemployment, income distribution, labour supply