This article examines the effects of unemployment compensation
finance in a labor market in which firms pay efficiency wages. Two
self-financing unemployment compensation systems are compared: one in
which benefits are financed by a proportional payroll tax and another in
which experience rating is introduced by taxing firms in proportion to
their separations. We find that experience rating leads to less
unemployment, less shirking, and higher output.
An equilibrium unemployment model is used to compare the effects of
the use of an experience rating system and the use of a pure payroll-tax
to finance unemployment compensation. Study results indicate that, in
accordance with conventional wisdom, experience rating is a more
desirable finance system, in that it results in less unemployment than
would result from a pure payroll-tax system.