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.