Relative Effects of Labour Taxes and Unemployment Benefits on Hours Worked Per Worker and Employment

Over the past 3 decades, labour supply in Europe has declined by approximately 30% relative to the USA. The decline comes from hours per worker and employment. The present paper uses a matching model to study the effects of labour taxes and unemployment benefits. Labour taxes decrease hours and employment, with overstated adverse effects on hours if extensive margins are not considered. Unemployment benefits decrease employment and increase hours, with understated adverse effects on employment if intensive margins are not considered. In the baseline parameterization, labour taxes and unemployment benefits together explain approximately 75% of the declining labour supply in Europe relative to the USA.