Social Insurance Programs Have Large Labor Supply Effects

A 10 percent increase in unemployment insurance benefits is associated with about a 10 percent decline in work time.

Social insurance programs have a more pronounced impact on labor supply decisions than do changes in wages and taxes, according to a new NBER Working Paper by Alan Krueger and Bruce Meyer. In Labor Supply Effects of Social Insurance (NBER Working Paper No. 9014) Krueger and Meyer survey the empirical evidence on the labor supply effects of social insurance programs. They define social insurance as compulsory, contributory government programs that provide benefits to individuals who meet specified eligibility requirements, and generally to individuals who contribute to the program's financing. Through such programs as Unemployment Insurance (UI), Workers' Compensation (WC), and Social Security (OASDHI) society pools the risks associated with unemployment, injury and disability, and old age. In 1967, 15 percent of U.S. Federal government expenditures went to social insurance. By 1996, 33 percent of federal government expenditures were on social insurance, and that figure is forecast to reach 44 percent over the next five years.

Studies of UI that incorporate both the incidence and the duration of claims tend to estimate that the elasticity of lost work time with respect to the benefit is close to unity. That is, a 10 percent increase in unemployment insurance benefits is associated with about a 10 percent decline in work time. Studies of Workers' Compensation tend to find that elasticities of lost work time with respect to the benefit are between 0.5 and 1. These are much larger than the labor supply elasticities -- which are close to zero -- typically found for men in studies of the effects of wages or taxes on hours of work. They are also larger than the consensus range of estimates of the labor supply elasticity of women in response to wages and taxes, which are highly dispersed but centered around 0.4.

Krueger and Meyer conclude that it is misleading to use standard estimates of labor supply elasticities when designing and evaluating social insurance programs. Elasticities are larger when a labor supply response can occur easily through participation, or weeks worked, rather than adjustments in the number of hours worked per week. For female workers, labor supply elasticities typically depend on participation and weeks worked, the researchers say. Male labor supply elasticities, by contrast, are determined primarily by adjustment in the number of hours worked per week - and employees may have little flexibility in that regard.

The large labor supply responses associated with UI and WC benefits are greater than those associated with Disability Insurance and Social Security. Thus it is misleading to use only one estimate of the response of labor supply when evaluating and designing different programs. Part of the explanation for the difference may be that the long-term window of eligibility for Disability Insurance and Social Security means that short-term substitution effects of benefits for work are of less importance.

-- Andrew Balls