Firing tax vs severance payments – an unequal comparison
Abstract
Purpose
The purpose of this paper is to compare two elements of lay-off costs in a dynamic model of the labor market and analyze the differences for business cycle dynamics and welfare.
Design/methodology/approach
The paper builds a general equilibrium Real Business Cycle model and introduces firing costs and severance payments. Labor market frictions are assumed to follow the famous search and matching approach.
Findings
The paper finds that firing costs imply a higher volatility over the cycle and have stronger negative welfare effects. Severance payments have a lower volatility, reduce unemployment, and reduce welfare by a smaller amount.
Practical implications
Policy reforms should be aimed to use severance payments and reduce the ring cost component of lay-off costs.
Originality/value
Increasing welfare and a more stable business cycle could be supported by using severance payments instead of firing costs.
Keywords
Acknowledgements
JEL Classifications — D61, E24, E32
I wish to thank Steffen Ahrens, Christian Merkl, and Céline Poilly for highly valuable comments. In addition, I thank participants at the IAB/LASER Workshop “Increasing Labor Market Flexibility – Boon or Bane?”
Citation
Wesselbaum, D. (2014), "Firing tax vs severance payments – an unequal comparison", Journal of Economic Studies, Vol. 41 No. 5, pp. 721-736. https://doi.org/10.1108/JES-09-2012-0136
Publisher
:Emerald Group Publishing Limited
Copyright © 2014, Emerald Group Publishing Limited