Hoover Digest

How to Put Unemployment Insurance to Work

Sunday, April 30, 2000

The main purpose of unemployment insurance is to cushion temporary, unanticipated spells of unemployment. It is not intended to be a support system for those who are chronically out of work or those in industries with relatively high wages and high expected unemployment, like construction.

Unfortunately, it is difficult to eliminate the abuses of unemployment benefits without also eliminating the insurance aspect. Consider construction, where wages are high, in part to make up for seasonal unemployment. Few want to pay construction workers to vacation at the expense of workers and firms in other industries. But eliminating unemployment payments would prevent construction workers from receiving benefits during a recession adversely affecting the construction industry.

To reform the system so that it would provide needed insurance and reward firms and workers who stay off the unemployment rolls, the current subsidy program should become more of a loan program. Under this system, workers would receive benefits during spells of unemployment but would repay a portion of the benefits after returning to work. Firms whose workers stayed off the rolls would pay less; workers who did not draw down benefits would receive more take-home pay. Such a system, which could make most firms and workers better off, works as follows.

Most states now require firms to contribute to an unemployment fund based on some percentage of a worker's wage. Firms whose workers frequently draw from the fund are charged a higher rate. The ceilings built into this "experience rating" system mean that firms that frequently lay off workers pay no more for additional layoffs because they are already at the ceiling rate. At the other end are firms that contribute to the fund forever, even if none of the firm's workers has ever drawn one dollar of benefits, because the firm must contribute at the floor rate.

Rather than basing contributions on a firm's experience, the alternative system bases contributions on each worker's experience. New workers' employers would pay a base rate on their wages, say, 3.4 percent, until a target level was reached in a particular worker's account. Then the employer contribution would fall to half, in this case, 1.7 percent, which would go directly to the worker. Firms that kept workers off the unemployment rolls would benefit, as would workers who avoid using benefits. Firms would pay less and workers would receive more.

Unemployment insurance would still be available to workers who have lost their jobs. When the worker returned to work, the employer would again contribute at the 3.4 percent rate and the worker would contribute at a 2 percent rate until his account reached the target. At that point, employer contributions would again fall to 1.7 percent, which would go directly to the worker.

The new system provides incentives to workers to avoid taking benefits and to firms to retain workers. Benefits would still be available in cases of need, but those workers who try to exploit the system lose because they must repay their benefits and do not receive the increased take-home pay of stable workers.