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Firing tax vs severance payments – an unequal comparison

Dennis Wesselbaum (Department of Economics, University of Hamburg, Hamburg, Germany and The Kiel Institute for the World Economy, Kiel, Germany)

Journal of Economic Studies

ISSN: 0144-3585

Article publication date: 2 September 2014

684

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

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