Unemployment Insurance: Economic stimulus . . .or drain?

By William B. Conerly, Ph.D.

A recent report published by the National Employment Law Project claims that "every dollar spent on unemployment insurance translates into $2.15 of economic activity in the states." UI payments, the report states, are "not a loss to our economy, but a benefit to businesses and working families."

In this hard-hitting In-Brief, economist William B. Conerly, Ph.D., shows why the NELP's study is flawed in its basic calculations and conclusions, and offers a point-by-point summary of the problems with Washington's current unemployment insurance program.

The attorneys (and one "policy analyst") of the National Employment Law Project have written a paper about the economic aspects of Washington state's unemployment system. Their approach is based on a simplistic Keynesian model that does not reflect the realities of a 21st Century economy, nor the vast literature on the harmful effects of the unemployment insurance system.

Where Does the Money Go?

NELP argues that "… UI benefits are tantamount to payments to Washington businesses for goods and services." This is true for a minority of benefits, but not for the bulk of expenditures. Consider the federal government's survey of consumer expenditures (1). Housing is the largest expense for most families, and one that continues even when unemployed. Mortgage payments typically end up in the hands of the global investment community, which holds the mortgage-backed-securities into which most house payments go. Similarly, rent payments for many apartment complexes go to Real Estate Investment Trusts, traded on the New York Stock Exchange. Even locally-owned apartments send most of their rent payments to global mortgage holders.

The next largest expenditure is for transportation, with two of the largest subcategories being car payments and fuel. Like mortgage payments, car payments go to financial intermediaries on behalf of global investors. Fuel payments may end up in Houston or Saudi Arabia.

Some food spending does stay in the local economy, but part of the food budget goes to farmers and food processors located outside the area, or even outside the country.

In the analysis of regional economies, the scholarly literature recognizes substantial "leakages" of local spending to other parts of the country and to foreign economies. For that reason, efforts to help local economies with Keynesian spending stimulus are doomed to failure.

Where Does the Money Come From?

The NELP paper has totally ignored where the money comes from in the first place: working people. Although company treasurers write the checks that pay the UI taxes, workers foot the actual bill. Economic research has demonstrated conclusively that 80% to 100% of the cost of UI is borne by workers through lower wages. The best research on the subject points to 100% (2). In other words, UI benefits are nothing more than the return of money previously taken from workers.

One unintended side effect of the system is that it reduces private saving. In other words, when workers are required to participate in a forced savings scheme, they reduce their voluntary savings (3).

Although NELP may favor the current UI system as a compulsory savings scheme, Washington's actual UI system subsidizes some workers at the expense of others. Those workers who retain their jobs, or who rapidly find another job when laid off, are paying the costs of people who abuse the system and those who take a long time to find another job. The abuse of Washington's UI system is substantial, as Evergreen Freedom Foundation's research has shown. Furthermore, the federal government has found that 16% of the UI payments made in Washington in 2000 where improper. (2000 is the most recent year for which data are available.) This amounted to $134 million taken from some workers and improperly paid to others.

Does the Spending Get Multiplied?

The NELP attorneys cite an econometric study which found an increase in GDP of $2.15 for every dollar spent on UI benefits. That study, first of all, looked at the nation as a whole, where leakages are much lower than they are for a state. Thus, the $2.15 estimate is not useful for state-level analysis.

The larger problem with the $2.15 estimate is that it is derived from a model in which fiscal policy is not well connected to the financial markets. I have simulated such large scale econometric models, and their use always requires ad hoc assumptions about monetary policy and the financial system. To understand what happens to the economy, it is necessary to "follow the money."

In good times, more UI taxes are collected than benefits are paid out. The excess adds to the state's account within the federal unemployment insurance trust fund. That money is then used to pay for government programs entirely unrelated to unemployment insurance. The trust fund holds IOUs from the federal government, which are effectively promises to tax and borrow extra in the future to cover the needs of the UI trust fund. The UI money reduces the federal government's need to borrow, so financial markets have more money to meet private sector credit demands. Thus, the drain on the private sector from UI taxes is offset by the financing that is enabled by the balances in the UI trust fund.

In recessions, UI benefits payments exceed tax revenue, and the federal government makes up the difference by paying off the IOUs it had left in the trust fund. In order to do this, the federal government most likely borrows more, although it could also raise taxes or cut other spending. The expansionary effect of the UI benefits in recessions is offset by the extra borrowing (or extra taxes or reduced spending) by the federal government.

In other words, there is no magic stimulus from unemployment insurance.

Do Other States Subsidize Washington?

NELP asserts that half of Extended Benefits and all of Temporary Emergency Unemployment Compensation come from federal money. Unfortunately, there is no federal money. All of these funds are collected from taxes on jobs in the 50 states. Before the states receive such "stimulus," there has been a de-stimulus to the states. It is true that a particular state can be a net recipient of money, at the expense of other states. However, the extent of the state's gain is not measured by how much federal money it receives, but by the extent (if any) that federal money exceeds the federal taxes paid. The net gain to the state will still be small, however, because of the large leakages from local spending.

Are Washington's Benefits Too Generous?

Generous benefits may appear to be just a greater volume of forced savings. NELP asserts that the state's benefits are not too generous, because they are not more than half of average wages. However, NELP attorneys ignore the large economic literature on the effect of generous benefits. Research has consistently shown that higher benefits result in longer periods of unemployment for recipients (4).

Although NELP finds the UI system to be necessary because of layoffs, the system has actually been found to cause layoffs. Employers with cyclical or seasonal needs would, in the absence of UI, have to pay a premium to attract workers. But the UI system eliminates the need for premium wages, and the employers are not charged for the full cost of the extra unemployment benefits their workers receive. Thus, there is a subsidy to these firms from workers at other firms. Econometric research indicates that the cross subsidies within the UI system cause layoffs. The most conservative studies find that 5% of layoffs are caused by the UI system, while others find 30% of layoffs caused by UI. One analysis concluded that at the depths of recession, the UI system is responsible for half of all layoffs (5). Even worse, very high cross subsidies within the unemployment insurance system increase layoffs. Washington has a worse-than-average level of cross subsidization (6), so we expect the state to have more layoffs induced by the unemployment insurance system.

What Are Washington's Shortcomings?

NELP cites two shortcomings of Washington's UI system: that it "disfavors" part-time workers (using a word that must be in legal dictionaries, it being absent from everyday language) and it has overly stringent standards for new and occasional workers. NELP has actually raised a valid issue, though it sees only one side of the story. The flip side of these workers being ineligible is that their wages are taxed to fund a system which will deny them benefits. That is certainly unjust.

NELP's proposal of easy benefits eligibility, however, raises the real risk of people taking a job for a limited time period just to get UI benefits. Canada's generous UI system has led to the description of "lotto 10/40," because a worker in certain provinces who is laid off after 10 weeks of work will qualify for 40 weeks of benefits. This draws people into the workforce with the goal of getting a subsidized layoff. (Even with less generous benefits in the United States, there is a small flow of people into employment just because of the potential for unemployment insurance benefits. (7)) Recall that all benefits are paid by workers themselves. Any system which allows people to enter employment for a brief period of time and then collect benefits larger than the taxes on their wages, is a system that takes money out of the pockets of other workers.

The Real Problems in Washington

Washington state's unemployment insurance system actually discourages work. The high job taxes, the disincentives to reemployment, and the incentive to layoffs all work to keep unemployment artificially high. NELP's goal, to increase the dependency of workers on government, will harm workers. It might, however, help the attorneys who litigate employment law.

Notes:

1. U.S. Department of Labor, Bureau of Labor Statistics, "Consumer Expenditures in 2000," Report 958, April 2002.

2. Patricia Anderson, and Bruce D. Meyer, "The Effects of Firm Specific Taxes and Government Mandates with an Application to the U.S. Unemployment Insurance Program," Journal of Public Economics, Vol. 65 (1997). See the citations in this article for earlier research on the subject.

3. Jonathan Gruber, "The Consumption Smoothing Benefits of Unemployment Insurance," American Economic Review, Vol. 87, No. 1 (March 1997); Eric M. Engen and Jonathan Gruber, "Unemployment Insurance and Precautionary Saving," NBER Working Paper W5252 (September 1995).

4. Some of the studies that come to this conclusion are Ronald G. Ehrenberg and Ronald L. Oaxaca, "Unemployment Insurance, Duration of Unemployment, and Subsequent Wage Gain," The American Economic Review, Vol. 66, No. 5 (December 1976); Bruce D. Meyer, "A Quasi-Experimental Approach to the Effects of Unemployment Insurance," NBER Working Paper 3159 (November 1989); Bruce D. Meyer, "Unemployment Insurance and Unemployment Spells," Econometrica, 58(4), July 1990; Brian P. McCall, "The Impact of Unemployment Insurance Benefit Levels on Recipiency," Journal of Business and Economic Statistics, 13(2), April 1995; Kenneth Carling, Bertil Holmlund and Altin Vejsiu, "Do Benefit Cuts Boost Job Finding? Swedish Evidence from the 1990s," Economic Journal (October 2001).

5. Frank Brechling and Louise Laurence, Permanent job loss and the U.S. system of financing unemployment insurance, Kalamazoo, Mich.: W. E. Upjohn Institute for Employment Research, 1995; Donald R. Deere, "Unemployment Insurance and Employment," Journal of Labor Economics, 9(4), October 1991; Robert H.Topel, "On Layoffs and Unemployment Insurance," American Economic Review (vol. 73, September 1983); Patricia Anderson and Bruce D. Meyer, "The Effects of the Unemployment Insurance Payroll Tax on Wages, Employment, Claims and Denials," NBER Working Paper 6808, November 1998; David Card and Phillip B. Levine, "Unemployment Insurance Taxes and the Cyclical and Seasonal Properties of Unemployment", Journal of Public Economics, v. 53(1), January 1994.

6. Wayne Vroman, "Unemployment Insurance Tax Equity in Washington," The Urban Institute, January 1999.

7. Kim B. Clark and Lawrence H. Summers, , "Unemployment Insurance and Labor Market Transitions," in Martin Neil Baily, ed., Workers, Jobs, and Inflation. Washington, D.C.: Brookings Institution, 1982.

William B. Conerly is an economist with Conerly Consulting LLC of Portland, Oregon, whose research in labor economics is supported by the American Institute for Full Employment. Dr. Conerly earned a Ph.D. in economics from Duke University, is a member of Governor John Kitzhaber's Council of Economic Advisors, and is a Senior Fellow at the National Center for Policy Analysis.

Evergreen Freedom Foundation P.O. Box 552, Olympia, WA 98507 Phone: (360) 956-3482, Fax: (360) 352-1874 Email: effwa@effwa.org