A Structural Analysis of Labour Supply and Involuntary Unemployment in the Netherlands

Most structural models for labour supply ignore the possibility of involuntary unemployment which may lead to biased behavioural responses. We estimate a structural model for labour supply without and with involuntary unemployment for the Netherlands. We find that average labour supply elasticities are only slightly lower in the model with involuntary unemployment than in the model without involuntary unemployment. The main reason for this small bias is the relatively small share of individuals who are involuntarily unemployed in our data period. A simulation of tax-benefit reforms confirms that the upward bias in average labour supply responses is limited in the model without involuntary unemployment. Hence, this study provides empirical evidence that the standard labour supply model, without rationing, gives a good prediction of the effects of tax reforms when the level of (involuntary) unemployment in a country is not too high.