Payroll Taxes, Social Insurance and Business Cycles

Abstract

Payroll taxes represent a major distortionary influence of governments on labor markets. This paper examines the role of payroll taxation and the social safety net for cyclical fluctuations in a nonmonetary economy with labor market frictions and unemployment insurance, when the latter is only imperfectly related to search effort. A balanced social insurance budget renders gross wages more rigid over the cycle and, as a result, strengthens the model's endogenous propagation mechanism. For conventional calibrations, the model generates a negatively sloped Beveridge curve as well as substantial volatility and persistence of vacancies and unemployment.

Keywords: consumption-tightness puzzle, unemployment, payroll taxes, labor markets, business cycles

JEL Classification: E24, J64, E32