The Long-Term Externalities of Short-Term Disability Insurance
This paper shows that employer-provided short-term disability insurance (STDI) increases long-term disability insurance (LTDI) take-up and imposes a negative fiscal externality on the government budget. Expanding private STDI has been touted as a way to lower public LTDI costs by giving employers a financial incentive to provide workplace accommodations. But private STDI can also raise public LTDI costs, since STDI generates moral hazard by providing benefits during the waiting period for LTDI. Using variation in private STDI coverage caused by Canadian firms ending their plans, I find that the moral hazard effect dominates and private STDI raises two-year flows onto LTDI by 0.07 percentage points (33%). Extrapolating to Canada’s entire population, private STDI generated 18,300 LTDI recipients and CA$230 million dollars (5%) of public LTDI spending in 2015. The efficient Pigouvian tax on Canadian private STDI that internalizes this externality is approximately CA$35 per insured worker.
I am grateful to David Autor, Amy Finkelstein, and Heidi Williams for their advice and support throughout the preparation of this paper. Jon Gruber, Nathan Hendren, Peter Hull, René Morissette, Daniel Waldinger and Ariel Zucker provided valuable comments and feedback. Serafina Morgia and other anonymous experts generously shared their knowledge of the institutions of Canadian disability insurance and employment law. Any remaining errors are my own. Financial support was provided by the Social Sciences and Humanities Research Council of Canada. The views expressed in this paper do not necessarily reflect the views of Statistics Canada or any department of the Government of Canada.