What’s Wrong with Government Unemployment Programs and How to Fix Them

October 17, 2011

Today we released a new study on federal and state unemployment programs, detailing how the current system works, the problems it’s facing, and what possible reforms government agencies can adopt to imporve things. Below are a few of the report’s key findings:

•Unemployment insurance (UI) is a social insurance program jointly operated by the federal and state government. Employers pay federal and state UI taxes that fund benefits, with employers paying different tax rates based on their layoff history (“experience rating”).

• High rates of unemployment and benefits lasting up to 99 weeks have led 34 states to borrow over $37 billion from the federal government to pay benefits. States are not expected to repay these amounts for some time and must begin paying interest on their balances in 2011.

• Businesses are in danger of facing higher UI taxes at a time when private sector hiring is already at a low level. Some states are already reducing UI benefits or raising taxes.

• States routinely cut UI taxes in good economic times and raise them in bad economic times, undermining the argument that the program is countercyclical.

• Modest UI reforms should be considered, including eliminating the “firewall” between administrative costs and benefits, reducing cross-subsidies to high-layoff employers, and relying more on face-to-face training and advising. More significant reforms that could be considered include adopting elements of state workers’ compensation programs and experimenting with individual accounts.

• Economic evidence suggests that extending unemployment benefits increases unemployment by encouraging “excessive search.”

• States should be sure that their UI tax systems are not overly complex and burdensome, particularly to new employers. States should also balance the goal of spreading the costs of unemployment to all employers with the danger of overly subsidizing high-turnover employers. Finally, states should resist efforts to introduce need-based features into UI.

Tax Foundation Background Paper No. 61, “Unemployment Insurance Taxes: Options for Program Design and Insolvent Trust Funds,” by Joseph Henchman is available here.

Update: Already cited by the Associated Press!

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