We exploit policy discontinuities in Poland’s unemployment insurance (UI) to examine the causal effect of changes to both benefit durations (how long a worker can receive benefits) and levels (how much a worker receives per month). We examine whether UI-induced moral hazard extends beyond job seekers to influence the behavior of employed workers as well.
Using a regression discontinuity approach, we uncover three findings: (1) Higher benefit levels distort employment more than benefit extensions. (2) Benefit durations and levels interact: Longer durations substantially increase the distortionary effect of more generous payments. (3) Higher payments increase the transition of employed workers into unemployment.
We incorporate our findings into an extended Baily-Chetty model of optimal benefits, considering the social welfare implications of UI in the presence of endogenous inflows into unemployment (where the baseline Baily-Chetty model assumes that layoffs are exogenous) and the moral hazard interactions of benefit generosity and benefit duration. We conclude that including the effects of moral hazard among the employed significantly increases the understood fiscal costs of UI, in particular of increases in the benefit level.