How to fund unemployment insurance with informality and false claims: Evidence from Senegal

This paper studies the welfare effects from the provision of unemployment insurance (UI) benefits in a context where formal workers represent only a small proportion of the labor market and informal workers can submit fraudulent claims for UI benefits. We model these features and allow for varying degrees of enforcement and different funding sources. We then estimate the model’s key parameters by conducting a custom labor force survey in Senegal. Our findings show that the liquidity gains are large and the moral hazard response to the UI benefits among workers is relatively small: an extra dollar of UI benefits yields a consumption-equivalent gain of 60–90 cents, which exceeds comparable estimates from U.S. calibrations by a factor of three to sixteen. We then show that the welfare gains depend on the program design: UI funded through payroll taxes delivers the greatest welfare gains but becomes infeasible when there are few formal workers and high rates of fraudulent claims. On the other hand, UI funded through consumption taxes delivers lower welfare gains but remains feasible with high informality and false claims. •Unemployment Insurance (UI) can provide large welfare gains in Senegal despite high informality and false claims.•Liquidity effects of UI dominate moral hazard effects in the Senegalese context.•Payroll tax-funded UI yields higher gains but becomes infeasible with high false claims.•Consumption tax-funded UI remains feasible even with high rates of false claims.•UI welfare gains 3–16 times larger than U.S. estimates due to consumption gaps and risk aversion.