Firing Tax vs. Severance Payment - An Unequal Comparison

Wesselbaum, Dennis (2010): Firing Tax vs. Severance Payment - An Unequal Comparison.

Abstract

Empirical evidence indicates that lay-off costs consist of two elements, namely firing costs and severance payments. This paper investigates business cycle and steady state effects of firing costs and severance payments and discusses the differences. We find that severance payments imply a lower volatility of key labor market variables compared with firing costs. Persistently increasing those costs, reduces the welfare in the model economy, but increases employment. The reason for the different performance is the impact on the wage and the additional stimulus caused by severance payments. The social planner therefore faces a trade-off in the design of employment protection. Furthermore, the appropriate design of lay-off costs also has strong implications for the design of other elements of employment protection.

• Item Type: MPRA Paper
• Language: English
• Keywords: Firing Costs, Severance Payments, Welfare.
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy > E24 - Employment ; Unemployment ; Wages ; Intergenerational Income Distribution ; Aggregate Human Capital ; Aggregate Labor Productivity; D - Microeconomics > D6 - Welfare Economics > D61 - Allocative Efficiency ; Cost-Benefit Analysis

References

Brown, Alessio J. G., Merkl, Christian, and Snower, Dennis J. (2009): "An Incentive Theory of Matching." Kiel Working Paper No. 1512, April 2009.

Burda, Michael C. (1992): "A Note on Firing Costs and Severance Benets in Equilibrium Unemployment." The Scandinavian Journal of Economics, Vol. 94(3), pp. 479-489.

Cozzi, Marco, Fella, Giulio, and Violante, Gianluca (2010): "The Non-neutrality of Severance Payments with Incomplete Markets." mimeo.

Fella, Giulio (2009): "Optimal Severance Pay in a Matching Model." mimeo.

Fujita, Shigeru, Nekada, Christopher J., and Ramey, Garey (2007): "The Cyclicality of Worker Flows: New Evidence from the SIPP." Federal Reserve Bank of Philadelphia Working Paper, No. 07-5.

Fujita, Shigeru, and Ramey, Garey (2007): "Reassessing the Shimer Facts." Federal Reserve Bank of Philadelphia Working Paper, No. 07-2.

Fujita, Shigeru, and Ramey, Garey (2008): "The Cyclicality of Separation and Job Finding Rates." Federal Reserve Bank of Philadelphia Working Paper, No. 07-19.

Garibaldi, Pietro, and Violante, Giovanni L. (2005): "The Employment Effects of Severance Payments with Wage Rigidities." Economic Journal, Vol. 105(506), pp. 799-832.

Den Haan, Wouter J., Ramey, Garey, and Watson, Joel (2000): "Job Destruction and the Propagation of Shocks." American Economic Review, Vol. 90(3), pp. 482-498.

Hopenhayn, Hugo A., and Rogerson, Richard (1993): "Job Turnover and Policy Evaluation: A General Equilibrium Approach." Journal of Political Economy, Vol. 101(5), pp. 915-938, October 1993.

Krause, Michael U., and Lubik, Thomas A. (2007): "The (Ir)relevance of Real Wage Rigidity in the New Keynesian Model with Search Frictions." Journal of Monetary Economics, Vol. 54(3), pp. 706-727.

Ljungqvist, Lars (2001): "How Do Layoff Costs Affect Employment?" CEPR Discussion Paper, No. 3051, November 2001.

Lucas Robert E. (1987): "Models in Business Cycle." Basil Blackwell, New York.

Merz, Monika (1995): "Search in the Labor Market and the Real Business Cycle." Journal of Monetary Economics, Vol. 36(2), pp. 269-300.

Messina, Julian, and Giovanna Vallanti (2006): "Job Flow Dynamics and Firing Restrictions - Evidence from Europe." European Central Bank Working Paper, No. 602, April 2006.

Poilly, Celine, and Sahuc, Jean-Guillaume (2008): "Welfare Implications of Heterogeneous Labor Markets in a Currency Area," Documents de Travail 199, Banque de France.

Poilly, Celine, and Wesselbaum, Dennis (2010): "Evaluating Labor Market Reforms: A Normative Analysis." mimeo.

Ramey, Garey (2008): "Exogenous vs. Endogenous Separation." Mimeo, October 2008.

Shimer, Robert. (2005). "The Cyclical Behavior of Equilibrium Unemployment and Vacancies." American Economic Review, 95(1): 25-49.

Veracierto, Marcelo L. (2008): "Firing Costs and Business Cycle Fluctuations." International Economic Review, 49(1), February 2008.