- Optimal welfare and in-work benefits with search unemployment and observable abilities
- Journal of Economic Theory
- Volume | Issue number
- 126 | 1
- Number of pages
- Document type
- Faculty of Economics and Business (FEB)
- Amsterdam School of Economics Research Institute (ASE-RI)
This paper explores the optimal interaction between the tax system and social assistance in insuring people against the risks of involuntary unemployment and low ability. To that end, we introduce search unemployment in a model of optimal non-linear income taxation. The relationship between welfare benefits and the optimal level of in-work benefits is U-shaped. This explains why in-work benefits are called for both in countries that grant low welfare benefits and countries that provide high welfare benefits. An earned-income tax credit optimally induces all agents to look for work if job search is cheap and effective, agents are not very risk averse, and the least-skilled agents are relatively productive.
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