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 em-ployed. 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 af-ter 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 U.S. system.