Relative Effects of Labor Taxes and Unemployment Benefits on Hours Worked per Worker and Employment

Labor supply in Europe was declined by about 30% relative to the US over the past 3 decades. The decline comes from hours per worker and employment. This paper studies a matching model and the effects of labor taxes and unemployment benefits. Labor 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 baseline, labor taxes and unemployment benefits together explain about 75% of declining labor supply in Europe relative to the US.