Working Paper

Firing Tax vs. Severance Payment - An Unequal Comparison

Kiel Working Papers, 1644

This paper compares two elements of lay-o¤ costs, namely firing costs and severance pay-

ments. Firing costs are a wasteful tax paid by the firm, while severance payments are a transfer

from the firm to the worker in case of separation. We develop a general equilibrium RBC model

that allows to explicitly distinguish between those two costs. We find that firing costs imply a

higher volatility over the cycle and have stronger negative welfare effects. Severance payments,

as they act as an automatic stabilizer, have a lower volatility, reduce unemployment, and re-

duce welfare by a smaller amount. Policy reforms should therefore be aimed to use severance

payments and reduce the firing cost component of lay-off costs.


Dennis Wesselbaum


Publication Date
JEL Classification
D61, E24, E32