The Welfare Effects of Extending Unemployment Benefits: Evidence from Re-employment and Unemployment Transfers

Abstract

This paper investigates the welfare effects of extending unemployment benefits by comparing thesearch effort responses to income transfers when employed (i.e. re-employment bonus) and unemployed(i.e. extended benefits). Specifically, we use administrative data on the universe of unemployment spellsin Taiwan from 2001 to 2011 and evaluate effects of providing a re-employment bonus and extendingunemployment benefits. Our results suggest that the provision of re-employment bonus increases job-finding hazards and results in the positive fiscal externality. The behavioral costs per New TaiwaneseDollar (NTD) of initial spending on bonuses is−0.61. In contrast, extending unemployment benefitsreduces the rate of unemployment exit and generates the negative fiscal externality. We integrate theestimated policy effects with a search model with liquidity constraints to identify the value of extendingunemployment benefits captured by the marginal rate of substitution (MRS) between consumption whenunemployed and employed. We find that the estimated MRS of extending benefits is around 1.5 to 2.5— the marginal value of transfers when unemployed is about two times larger than that when employed.Finally, the marginal value of public fund for extending UI benefits is between 1.3 and 2, suggesting thewelfare gain from benefit extension is larger than its welfare cost by more than 30%.