Expanding a Broken System Only Widens the Cracks

With unemployment steadily rising, so are complaints about Unemployment Insurance (UI). The primary complaint, as recently stated by the Oregonian editorial board (“Oregon’s Jobless Plunge Through Holes in Safety Net,” Jan. 23, 2009), is that the UI system is unfair and fails to cover many deserving workers. Reforming the current system to cover more workers is a laudable goal, but legislators must be careful not to compound other serious problems with UI.

To have a valid claim for UI benefits, a worker must have left work involuntarily and not as a result of misconduct. The claimant also must be actively looking for work and available for full-time employment.

UI was created in the 1930s when the workforce was mostly full-time working men. The system has not changed much, but the workforce has. As a result of these old rules, women are much less likely to receive benefits when unemployed, since they still tend to be the primary caregivers in most families, and so they are frequently leaving work voluntarily or are unable to take full-time work because of family responsibilities.

Low-wage workers are also less likely to qualify, since UI requires that a person either work a minimum number of hours or earn a minimum amount. Likewise, part-time workers generally do not benefit because they either do not work enough to qualify or cannot accept full-time employment. For decades, UI’s basic requirements have caused fewer than 40% of workers in the U.S. and in Oregon to receive unemployment benefits.

Noticing this disparity, activists are demanding expanded UI coverage. The Unemployment Insurance Modernization Act, which has been tacked onto the current version of the proposed federal stimulus bill, provides an incentive to states to modify UI to ameliorate some of these more publicized inadequacies. It would extend the federal payroll tax at its current raised rate until 2012 and would offer federal incentive payments to states willing to cover a larger portion of unemployed workers.

One-third of federal incentive payments would go to states that sufficiently modify the time frame used to determine eligibility, which would make it easier for some low-wage workers to make claims. The other two-thirds would go to states that would expand coverage to include enough of the following: workers who cannot accept full-time work, or who voluntarily leave work for a compelling family reason, payment of additional UI to workers in approved training programs, and additional allowances for dependants.

The bottom line of these amendments is that they would expand UI coverage, costing the government additional money, unless the current size or duration of benefits is diminished. Increasing taxes would further stunt the economy’s recovery and growth. Better solutions are needed which also can address the other evils of the current UI system.

What are the other evils of UI? At the top of the list: increasing coverage increases the unemployment rate. Economists have established conclusively that workers who receive unemployment benefits stay unemployed more than twice as long as their counterparts. And bigger benefits cause recipients to remain unemployed longer.

A significant part of unemployment is caused by the “frictional unemployment” of employers waiting for the employee with the right “fit” to apply. UI increases this frictional unemployment since workers take longer to find work, causing employers and society at large to suffer, paying more for unemployed workers and producing less work and thus less wealth.

Another major problem is that UI itself actually encourages many employers to lay off workers. Employers must pay higher payroll taxes (which fund unemployment insurance) when they lay off workers. However, tax increases do not fully reflect the cost to the system. Employers have discovered that they can use this disparity to essentially subsidize the cost of business in some industries. In fact, studies have conclusively shown that UI causes an increase in all layoffs, particularly in temporary layoffs. In the depths of recession, one study concluded that UI causes up to half of layoffs.

Without additional reform, the government’s attempt to expand coverage to more workers would only increase these problems. Already, legislators in Oregon are looking to implement some changes described in the Unemployment Modernization Act. But UI needs a serious overhaul, not just a band-aid to make it appear as if the system works.

A number of innovative ideas could make UI work for more people and would help solve its other problems. One idea currently working in Chile and elsewhere is to give every worker property rights in UI while limiting each worker’s coverage. However, federal law currently punishes states that stray too far from the structure of the present system.

Instead of merely expanding unemployment coverage under a broken system, activists and Oregon legislators should focus on getting the federal government to loosen restrictions to allow them to find and implement a system that works better for individuals and the economy at large. UI is antiquated; and true modernization will require real innovation, not more of the same.

Christina Martin is Director of the Asset Ownership Project and a policy analyst for the School Choice Project at Cascade Policy Institute, Oregon’s free market public policy research organization.