You are hired by the presidential administration to review the UI program, which currently replaces approximately 45% of a worker’s wages for 26 weeks after she loses her job. Consider two alternative reforms of the current UI system. The first is to experience rate firms fully, so that the taxes firms pay are set exactly equal to the benefits their workers receive (benefits remain at 45% of wages). The second is a system of individual full experience rating—the government would loan individuals 45%of their wages while unemployed, but they would have to pay this back when they get new jobs.
a. Contrast the effects of these alternative policies on unemployment durations and the likelihood of worker layoffs.
b. What are the consumption-smoothing properties of each alternative policy?