Social Program Substitution and Optimal Policy

A growing literature on substitution between social programs provides consistent evidence that changes in the generosity of one program can lead to changes in enrollment on other programs. However, this evidence has been ignored in welfare analyses of social insurance programs. I demonstrate that substitutions between programs can dramatically alter conclusions about optimal policy, with a particular focus on optimal unemployment insurance (UI) when there is substitution between UI and disability insurance (DI). If more generous UI reduces enrollment on DI, the result is a reduction in government spending on DI, and I show that this effect can significant increase the optimal UI replacement rate from 3% to 85%.