Financing Unemployment Benefits through Fiscal Policies and Increasing Competition

We consider a model in which the labor market is characterized by search frictions and there is monopolistic competition in the goods market. We introduce proportional income taxation and unemployment benefits with Government balanced budget constraint. We then evaluate the effects of both more competition in the goods market and higher unemployment benefits on labor market equilibrium and the equilibrium tax rate. We show that greater competition has a positive effect on equilibrium unemployment and the Government budget. Higher unemployment benefits can be financed by either raising the tax rate or increasing goods market competition. With liberalization policies it would be possible: a) to avoid an increase in unemployment if we allow some rise in the tax rate; b) to decrease unemployment if they are incisive enough to keep the tax rate unchanged.