Economics Brown Bag Seminar Series - Yusuf Mercan (The University of Melbourne)

Title: UI and DI: Macroeconomic Implications of Program Substitution

Abstract: We study the substitutability of two large income replacement programs in the United States: Unemployment Insurance (UI) and Social Security Disability Insurance (DI). We investigate empirically the effect of the duration of unemployment benefits on the applications for DI and the number of beneficiaries. Using variation in the timing and magnitude of UI extensions across states during the Great Recession, we find that benefit extensions are associated with declines in DI applications. To obtain causal inference, we use two identification strategies. First, using a synthetic cohort and exploiting the sharp and unexpected decline in benefit durations in Missouri in April 2011, we find a sizable increase in DI applications coming from the decline in the duration of unemployment benefits. Second, we use a border discontinuity design and find that the number of DI beneficiaries decreases in response to extensions of benefit durations. Motivated by these findings, and to understand the implications of the two programs for policy, we construct a search model of the labor market with worker heterogeneity in health and skills. In times of low job finding rates, marginal workers claim DI as opposed to UI. The relative generosity of UI and DI benefits affects who uses which program. In particular, extending the duration of UI benefits limits the number of nonemployed individuals that use DI to replace lost income. This effect keeps more workers attached to the labor force and leads to compositional changes by drawing in people with worse health conditions and lower productivity, thereby putting downward pressure on job finding rates. At the same time, by cutting the costs, UI extensions lead to a lower tax rate, which in turn boosts the labor market. We calibrate the model and use it to quantify these tradeoffs and to evaluate the implications of the program substitution for the labor market.