Effect of Unemployment Insurance Tax On Wages and Employment: A Partial Equilibrium Analysis

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1 Effect of Unemployment nuance Tax On Wage and Employment: atial Equilibium nalyi Deegha Raj dhikai, Oklahoma Employment Secuity Commiion ynn Gay, Oklahoma Employment Secuity Commiion Jackie Bun, Texa & M Univeity JE Claification: J3 Key Wod: unemployment inuance tax, wage, employment btact We develop a patial equilibium model unde a cot minimization poblem to deive the effect of an unemployment inuance tax on aveage wage ate and employment We aume pefect competition in the poduct maket and pefect facto mobility in the facto maket Ou model ugget that a potion of the tax i paed on to employee by mean of educed wage The model alo ugget that a lowe level of employment will be ealized a a eult of the tax Deegha Raj dhikai 240 N incoln Boulevad Oklahoma City, OK 7352 hone: Fax:

2 Effect of Unemployment nuance Tax On Wage and Employment: atial Equilibium nalyi btact We develop a patial equilibium model unde a cot minimization poblem to deive the effect of an unemployment inuance tax on aveage wage ate The model ugget that a potion of the tax i paed on to employee by mean of educed wage ntoduction The unemployment inuance U tax i a fedeal tax collected by the US govenment fom employe aco the county Mot of the tax evenue i then tanfeed to the elated tate in tem of Unemployment nuance Tut Fund Thi fund i then ued by the tate to pay compenation to unemployed woke actively eeking job The U tax i expeience ated, which mean each employe doe not pay the ame tax amount fo each of it employee n the poduct maket, howeve, each employe face moe o le the ame pice line Thi ituation give ie to the belief that employe mut have incentive to hift uch taxe in ode to tay in the maket With diminihing etun in poduction, a downwad hift could take place in tem of a lowe payment to the woke, 2 a eduction in the employment, o 3 a lowe payment to the facto whoe upply i le elatic Fom a policy pepective, analyzing the ultimate incidence of an unemployment inuance payoll tax and it effect on wage and employment i vey ueful 2

3 n the pat, thee have been a few wok done on the incidence of U tax n hi eminal pape, ete 962 aumed a competitive equilibium in both poduct and facto maket and concluded that the fim themelve bea mot of the incidence of a U tax Hamemeh 977 take thi iue to the long un and conclude that the conume and the woke of a fim hae the incidence almot equally aticia and Meye 997, uing data fom eight tate fo the yea fom 978 to 984, analyzed the effect of U tax on wage and employment They concluded that individual fim ae only able to pa on a mall potion of U tax that, in tun, lead to ubtantial employment eallocation aco fim They alo conclude that expeience-ated taxe can be ued to educe a tempoay layoff, a the diffeence in taxe ae not eaily hifted to woke The wok done o fa on the incidence of U tax have motly deived thei eult fom a labo maket equilibium condition Thee tudie implicitly aume a cot minimizing behavio on the pat of the fim Ou pape will explicitly analyze the cot minimizing behavio of the fim in a competitive maket and how how a change in U tax affect the equilibium wage and employment Section 2 peent a theoetical model and deive the eult Section 3 conclude the theoetical eult 2 The Model We aume that the typical fim only employ two facto and poduce a ingle good with a technology epeented by the Cobb-Dougla poduction function a follow: K, whee i a contant facto, K and ae amount of capital and labo epectively, and and ae coefficient of capital and labo epectively The cot function of the fim i aumed to be linea a follow: 3

4 C K, 2 whee C i the total cot, i the tax-included wage ate, and i the inteet ate facing the fim Suppoe the fim pay unemployment inuance tax to the fedeal govenment, which i collected pe unit of labo at the ate of T Theefoe, the tax-included wage ate can be expeed a follow: W T, 2a whee W i the wage ate The cot-minimization poblem fo the fim, given the output containt and chaacteized by the Cobb-Dougla poduction function, can be hown a follow: Ω K λ - K 3 Fit Ode Condition: Ω Ω K K λ 0 4 λ 0 5 K Ω λ K 0 6 Taking the atio of equation 4 and 5 yield K Solving fo yield K 7 Subtituting equation 7 into 6 yield 4

5 5-0 K K Solving the above equation fo K yield K 8 Subtituting the value of K into equation 6 yield Solving fo yield Solving fo yield 9 Subtituting equation 8 and 9 into 2 yield C

6 Denoting by, the above equation can be ewitten a C [ ] Denoting [ ] C by, the above expeion can be ewitten a Suppoe, the fim evenue function i Cobb-Dougla type a follow: R B δ θ, whee B i a contant, i the pice of labo, and i the pice of capital We aume that thee i pefect competition, o that the fim make no economic pofit, and it total evenue R i equal to it total cot C uch, we have the following equilibium condition: B δ θ Reaanging the tem in the above equation yield δ B θ Solving the above equation fo yield 6

7 γδ γδ γθ γδ Since W T a hown ealie, decompoing it yield W T γδ γθ γδ γδ 0 Suppoe the unemployment inuance tax i a contant function of the wage ate uch that T tw Then, equation 0 can be ewitten a W tw γδ γδ γθ γδ Reaanging the tem in the above equation yield W t γδ γδ γθ γδ t γδ θγ γδ γδ Taking log of both ide yield nw ln γδ γθ ln t ln ln γδ γδ ln D ln ln

8 whee 0 ln γδ,, D t, 2 γδ, and γθ 3 γδ Since D t W T by aumption, etimating equation 2 with etiction that and teting if i negative will how if unemployment inuance tax t negatively affect the wage ate n othe wod, a negative indicate that the employe i able to hift at leat ome of the buden of unemployment inuance tax to the employee by offeing educed wage Effect of Unemployment nuance Tax on Wage Diffeentiating equation with epect to t yield dw dt t 2 S B γδ γδ γθ γδ dw Since t, S, B,, and ae all poitive, < 0 dt Thi implie that an inceae in tax ate caue the wage ate to deceae The eult ugget that the employe pae a pat of the unemployment inuance tax on to the employee by offeing educed wage With othe facto emaining the ame, thi implie that the equilibium level of wage deceae with the inceae in unemployment inuance tax 8

9 Effect of Unemployment nuance Tax on Employment The equilibium level of labo demand i given by the equation 9, which can be ewitten a W tw, whee pice of labo,, i equal to the aveage wage ate, W, and the unemployment inuance tax, T, which i t th faction of the wage ate The above equation can be eaanged a follow: W t 3 Diffeentiating equation 3 with epect to t yield d dt W 2 t d Since,,, W,,, and t ae all poitive, < 0 Thi mean that an inceae in the dt tax ate educe the equilibium level of labo demand With othe facto emaining the ame, thi implie that the whole labo demand cuve hift downwad following the intoduction of the tax Theefoe, the equilibium level of employment deceae with the inceae in unemployment inuance tax 9

10 3 Concluion Ou pape theoetically examine the incidence of unemployment inuance U tax on equilibium level of wage and employment at eeache on the incidence of U tax ae mainly baed on labo maket equilibium condition and implicitly aume a cot minimizing behavio on the pat of the fim n ou pape, we explicitly analyze the cot minimizing behavio of the fim in a competitive maket and how how a change in U taxe affect the equilibium wage and employment Ou eult ugget that the U tax negatively affect the equilibium level of wage and employment Refeence ndeon, aticia M and Buce D Meye ugut 995 The ncidence of a Fim- Vaying ayoll Tax: The Cae of Unemployment nuance, NBER Woking ape No W520 ndeon, aticia M and Buce D Meye Dec 995 The Effect of Unemployment nuance Taxe and Benefit on ayoff Uing Fim and ndividual Data, NBER Woking ape No W4960 ndeon, aticia M and Buce D Meye 997 The Effect of Fim Specific Taxe nd Govenment Mandate with an pplication to the US Unemployment nuance ogam, Jounal of ublic Economic, v 65, 9-45 Hamemeh, DS 977 Joble ay and the Economy, John Hopkin Univeity e, Baltimoe Kamaz, Fanci and Thoma hilippon Oct 200 The mpact of Diffeential ayoll Tax Subidie on Minimum Wage Employment, Jounal of ublic Economic, v, 82, no, pp 5-46 Kolm, nn-sofie Nov 998 Diffeentiated ayoll Taxe, Unemployment, and Welfae, Jounal of ublic Economic, v, 70, no 2, pp ete R 962 The Economic of Unemployment Compenation, ndutial Relation Section, inceton Univeity, inceton, NJ 0

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