Rethinking unemployment insurance: Part II

Picking up on the recent unemployment insurance post about Jeff Kling’s proposal for a revenue-neutral reform of unemployment insurance that would create earnings replacement account, funded by workers, that would help them through short-term job layoffs, allowing government-funded unemployment insurance to be used for long-term layoffs or permanently lower wages in new jobs that can be especially damaging.

Kling makes the argument that his proposal will actually reduce temporary layoffs by 10-15 percent and permanent layoffs by an unspecified amount. How? By forcing firms to bear the costs of unemployment. Under the current unemployment insurance system, firms make payments to the government to cover payments. Kling proposes that firms contribute to government coffers for for wage-loss insurance, repayment insurance, assistance on earnings replacement accounts for those with lower wages. Since the proposal is revenue neutral, the total costs to these forms of insurance would be the same as they are now. But Kling proposes raising the taxable earnings base to a real value of $90,000 (in some states it is currently below $10,000), cutting the overall unemployment insurance payroll tax rate, and lowering the minimum amounts that firms must pay. The result, Kling says, would be a tighter linkage between layoffs and direct firm costs. Intra-firm subsidies for unemployment insurance would thus be reduced.

In addition, since most employees who become unemployed would bear the costs of unemployment benefits directly, they would be much more likely to voice strong opposition to temporary layoffs than they are under UI when they receive payments with no corresponding future obligations. Firms in industries with frequent temporary layoffs would be pressured by the labor market to raise wages in order to continue to attract workers who, under the proposal, would be self-insuring income loss during layoff through savings and borrowing.

Addendum to previous post on unemployment: Here is one more reason why individuals might be more likely to return to work faster under Kling’s plan. Recent research by economist Raj Chetty argues unemployment insurance raises some problems of moral hazard, but that equally serious effects come from something he calls the “liquidity effect.” (A gated version of his working paper is here.) In essence, unemployment benefits allow an individual to remain out of work longer since they have enough cash-on-hand to survive. But if workers have to use the money they saved themselves through their earnings replacement accounts to fund their short-term unemployment, they could be more motivated to find a job. Certainly more motivated than if the entire insurance check was coming out of some other taxpayer’s pocket.


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