5. A member of Congress proposes a law to provide unemployment insurance. Resear

Question

5. A member of Congress proposes a law to provide unemployment insurance. Research finds that when workers are uninsured, their average spell of unemployment per year per worker is 2 weeks, and the maximum time that any worker was unemployed was 52 weeks. The plan promises benefits equal to each worker’s wage for up to 52 weeks of unemployment. It proposes to finance these benefits by a tax of 4 percent on the weekly wage (2 weeks of unemployment per year/50 weeks worked per year = 0.04). (a) What is the moral hazard in this proposed plan? (b) Do you think the 4-percent tax will raise rev- enue equal to the expected payout? Why or why not? (e) What measure would you sug- gest to reduce the moral hazard? (Hint: Consider something equivalent to a deductible and/or a co-pay.)

Explanation / Answer

(A). There is a serious moral hazard hidden in this proposed plan. The plan of benefitting the workers from a wage for up to 52 weeks of unemployment will discourage the worker's motivation to look up for new job in the time of their unemployment. Thus the inducement to work and earn wages would reduce in the worker's class. This would result in a moral hazard of putting less effort by the workers and thus increasing the rate of unemployment in the long run.

(B). Yes, a 4-percent tax on the weekly wage would be able to raise revenue equal to the expected payout. This is so because, the amount of benefit paid to the workers during the time period of their unemployment would be recovered from them in the form of a 4 percent tax.

(C). To reduce the moral hazard a plan of co- pay would be a good option, as the benefits recieived by the enemployed workers would be from their own savings/an insurance whose premium has been paid by the worker out of his own pocket, and this would induce the worker to look up for a new job in order to sustain in the long run.

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