Unemployment Insurance Fraud and Optimal Monitoring

An important incentive problem for the design of unemployment insurance is the fraudulent collection of unemployment benefits by workers who are gainfully employed. We show how to efficiently use a combination of tax/subsidy and monitoring to prevent such fraud. The optimal policy monitors the unemployed at fixed intervals. Employment tax is nonmonotonic: it increases between verifications but decreases after a verification. Unemployment benefits are relatively flat between verifications but decrease sharply after a verification. Our quantitative analysis suggests that the optimal monitoring cost is 60 percent of the cost in the current US system.