1999 Articles

Taxation, Public Policy, and Dynamics of Unemployment

Stiglitz, Joseph E.

This paper provides an overview of the key issues relating to taxation, public policy and the dynamics of unemployment. It takes issue with the widely held view that generous social insurance schemes and the associated high payroll taxes have been the major cause of the high unemployment rates which have persisted in Europe over the past 15 years. It puts forward a framework for a theory of adjustment, based on the portfolio theory of the risk averse firm and the efficiency wage theory of labor markets. This is used to explain why in the onset of a downturn, the hiring rate may lag the layoff rate, thus giving rise to rising unemployment rates. It is also shown to provide guidance as to policies which enhance the ability of firms to bear risks and which reduce costs of hiring and firing. The paper argues that while policies which increase severance or layoff costs may be well intended they may actually serve to exacerbate the magnitude of employment fluctuations. Similarly, unemployment compensation, which is designed to ease the burden on those who are unemployed, may lead to higher levels of equilibrium unemployment. These programs can be restructured in ways which simultaneously ease the short-run burden of those thrown into unemployment, while reducing the adverse impact of these programs on the unemployment rate.