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State unemployment compensation programs: immediate reforms needed.

State Unemployment Compensation Programs: Immediate Reforms Needed

Introduction

State unemployment insurance (UI) programs have serious defects that require immediate reforms. The most glaring defects are the relatively low proportion of unemployed workers who receive UI benefits and inadequate trust fund reserves in most states. The primary purpose of this paper is to analyze the major defects in state UI programs and offer recommendations for improvements. Since substantial amounts of new revenues are necessary that may require a sharp increase in employer UI contribution rates, needed improvements are likely to be strongly opposed by employers. Thus, the authors argue that employees should be required to contribute to UI programs. The economic effects of a new payroll tax on employees and public policy implications are analyzed in some depth. The major conclusions of the study are that employee contributions could substantially increase the proportion of unemployed workers who receive benefits, improve the solvency of state UI programs, increase the effectiveness of UI as an automatic stabilizer, and encourage greater employee interest in the programs.

Defects in State Unemployment Insurance Programs

State unemployment insurance programs have serious defects that limit the effectiveness of the programs in reducing economic insecurity from involuntary unemployment. The most important defects are summarized as follows:

* Small proportion of unemployed who receive benefits

* Inadequate trust fund reserves in most states

* Greater difficulty in obtaining extended benefits

* Reduction in the effectiveness of experience rating

* Contestment of claims by employers

* Reduction in real UI benefits

* Decline in the effectiveness of UI as an automatic stabilizer

Small Proportion of Unemployed Receiving Benefits

The most serious defect in unemployment insurance (UI) programs is the small proportion of unemployed workers who receive benefits. Although about 97 percent of all wage and salary workers or about 85 percent of all employed persons are covered by UI programs, only a small fraction of the total unemployed at any time receives UI benefits (U.S. Congress, 1989, p. 440). In 1988, fewer than one in three unemployed workers received benefits in an average month (see Table 1). The record is not much better during business recessions. During the trough of the severe 1981-82 recession (November, 1982), only 49 percent of the unemployed received benefits. This compares with a peak of 81 percent of the unemployed who received UI benefits in April 1975 and a lowpoint of about 26 percent in October 1987 (U.S. Congress, 1989, p. 442). In contrast, foreign countries generally compensate a much higher percentage of unemployed workers. For example, in August 1984, Germany, Japan, and Sweden compensated over 60 percent of their unemployed, while the comparable figure for the United States was only 31 percent (U.S. Congress, 1987a, p. 329). The reasons for the decrease in the proportion of unemployed workers who receive UI benefits will be discussed later in the paper.

In addition, there is wide variation among the individual states. In four states (Florida, New Hampshire, South Dakota, and Virginia) fewer than one in five unemployed workers received benefits in 1987. Virginia had the lowest percentage with only about 17 percent of the workers receiving benefits in an average month. Only three states (Alaska, Massachusetts, and Rhode Island) paid benefits to more than half of the unemployed workers (see Table 2).

Reasons for the Decline. A recent study by Mathematica Policy Research, Inc. prepared for the U.S. Department of Labor provides valuable information on the reasons for the decline in the proportion of unemployed workers who receive benefits. To estimate the proportion of unemployed who received benefits, Mathematica used a measure called the UI claims ratio, which is defined as the ratio of average weekly UI benefit claims under state programs during a quarter to the state's average total unemployment during the quarter. The UI claims ratio has also declined significantly from the 1950s through the 1980s (see Table 3).

Table 4 summarizes the major reasons for the decline in the UI claims ratio for 1980 through 1986. A large part of the total decline can be explained by more restrictive and tighter state eligibility requirements and administrative practices, especially in states with insolvent trust fund accounts. These restrictive changes include increased monetary eligibility requirements and a reduction in the maximum potential duration of benefits (8 to 15 percent); an increase in disqualifying income denials (2 to 10 percent); and changes in other nonmonetary eligibility requirements (3 to 11 percent).

Changes in federal UI policy also accounted for a relatively large part of the decline in the UI claims ratio. These changes included a more restrictive extended benefits program (discussed later) and the partial taxation of UI benefits prior to the Tax Reform Act of 1986. In particular, the partial taxation of UI benefits accounted for between 11 to 16 percent of the total decline. It is argued that the after-tax value of UI benefits has declined significantly because of the taxation of benefits; thus, there is less financial incentive for unemployed workers to apply for benefits.

Other reasons for the decline in the UI claims ratio include shifts in the geographic distribution of unemployment and a decline in manufacturing unemployment relative to total unemployment. With respect to the latter reason, employment in manufacturing has declined while jobs in the services industries have expanded sharply. The result is a relative decline in manufacturing unemployment relative to total unemployment. Workers employed in manufacturing are more likely to belong to labor unions, and unions traditionally have encouraged unemployed workers to file for UI benefitis. In contrast, workers in the services industry are less likely to be unionized or may be monetarily ineligible for benefits. Thus, they are less likely to apply for benefits. The Mathematica study estimated that the decline in manufacturing employment explained 4 to 18 percent of the decline in the UI claims ratio for 1980 through 1986.

Finally, a more accurate measure of unemployment explained one to 12 percent of the total decline in the UI claims ratio. If unemployment had been measured more accurately in previous decades, the UI claims ratio would have been lower, and the decline in the UI claims ratio during the 1980s would have been less pronounced (Mathematica Policy Research, 1988, p. 39).

Violation of Social Insurance Principles. The fact that only a small proportion of unemployed workers receives benefits in an average month violates one of the most fundamental principles of social insurance--broad coverage of workers against well-defined social risks, including the risk of unemployment. Since only a small proportion of the total unemployed receives benefits at any time, the effectiveness of state UI programs in reducing economic insecurity from unemployment can be seriously questioned. In particular, the effectiveness of UI programs in reducing poverty for long-term unemployed workers has declined sharply. For example, unemployment benefits and other government benefits in 1976 reduced by 21 to 23 percentage points poverty rates for persons unemployed 40 to 52 weeks. However, in 1983, poverty rates for a similar group of long-term unemployed were reduced by only 14 to 16 percentage points by the payment of unemployment insurance and other benefits (Center on Budget and Policy Priorities, 1988, p. 10).

Inadequate Trust Fund Reserves

Another serious problem is that most states have inadequate trust fund reserves for paying benefits during a severe recession. As a result, many states will be unable to pay unemployment benefits in a future recession without substantial borrowing from the federal government. One commonly used measure to estimate the adequacy of a state's unemployment reserve account is known as the "high cost multiple." It is determined by the following formula:

High cost multiple = Ratio of current net trust fund reserves to current year total wages earned in insured employment / Ratio of highest state benefit payments during 12 consecutive months to total wages in insured employment during those 12 months

The U.S. Department of Labor recommends that states should have a cost multiple between 1.5 and 3.0. A state that meets the 1.5 standard would have net unemployment reserves 1.5 times greater than the fund's historically worst 12-month benefit period and would be able to pay benefits for at least 18 months during a recession without borrowing. However, at the beginning of 1987, the overall system had a high cost multiple of only .44, which meant that reserves would last only about five months during a severe recession. Although 39 states had adequate unemployment reserve accounts in 1969 based on the high cost multiple measure, only two states (Mississippi and South Dakota) had adequate reserve accounts in 1986 (U.S. General Accounting Office, 1988, p. 3).

States with inadequate reserve accounts can borrow from the Federal Unemployment Account. In 1983, 23 states had to borrow to continue benefit payments to unemployed workers. A state has between 22 and 34 months to repay a loan without penalty. If a state fails to make loan repayments on time, employers operating in the state are subject to penalty taxes in the form of an automatic reduction in the Federal Unemployment Tax Act (FUTA) tax credit. The credit reduction is at least 0.3 percent per year and accumulates until the loan is repaid in full. The penalty taxes essentially represent involuntary repayments of state loans and escalate with the duration of delinquency. However, total penalty taxes often can be substantial and can be viewed as a form of "loansharking" by the federal government. For example, Pennsylvania owed the Federal Unemployment Account about $203 million at the beginning of 1989. However, employers in Pennsylvania in 1989 will pay a surcharge that will more than double the amount owed by the state. Under the rates assessed in 1989, Pennsylvania employers will pay about $475 million in unemployment taxes and penalties which exceed the amount owed by $272 million (U.S. Congress, 1987b, p. 257). The excessive overpayments place a severe financial burden on employers, restrict the amount of capital available for economic development in the state, and retard recovery by the state during a recession.

Greater Difficulty in Receiving Extended Benefits

Another serious problem is that extended benefits are more difficult to obtain. Under the federal-state permanent extended benefits program, a maximum of 13 additional weeks of benefits can be paid to unemployed workers who exhaust their regular benefits. However, a change in the 1981 law made it more difficult for unemployed workers to receive extended benefits. A substantially higher level of unemployment in a state is now required before extended benefits can be paid. The 1981 amendments eliminated the national "on" indicator which triggered the payment of extended benefits when a national insured unemployment rate (IUR) equalled or exceeded 4.5 percent. The IUR is the ratio of UI claims to total employment covered by UI. The IUR is substantially below the total unemployment rate because some unemployed have not met the eligibility requirements, are not covered for UI benefits, or have exhausted their benefits.

The state's IUR is now used to trigger extended benefits, and it is substantially higher than the national IUR used earlier to trigger extended benefits. Extended benefits can only be paid when the state's 13-week IUR is 20 percent higher than its average weekly rate over the corresponding 13-week period during the last two years and is at least 5 percent. In addition, a state at its option can trigger the program when its current 13-week average IUR reaches 6 percent. All but 13 states have adopted the second IUR trigger.

The state's IUR is badly flawed as a measure of long-term unemployment within the state. After unemployed workers exhaust their benefits, they are no longer counted in the computation of the insured unemployment rate. Thus, states with severe long-term unemployment problems can have a relatively low IUR. If the state's total unemployment rate remains unchanged, but the number of unemployed who exhaust their unemployment benefits increases, the state's IUR can actually fall (U.S. Congress, 1987b, p. 242). As a result, at the present time, in those states hit hard by economic recessions and high unemployment rates, workers experiencing long-term unemployment are ineligible for extended benefits. In 1987, nine states with troubled economies had unusually high unemployment rates (Alaska, Arkansas, Louisiana, Michigan, Mississippi, New Mexico, Texas, West Virginia, and Wyoming). Unemployment rates ranged from 10.8 percent in West Virginia to 8.1 percent in Arkansas. Despite the high unemployment rates in those states, no state had an activated extended benefits program during the first week of January 1988 (U.S. Congress, 1988, pp. 338-40). Thus, extended benefits could not be paid to the long-term unemployed in those states.

Reduction in the Effectiveness of Experience Rating

Another defect is that the effectiveness of experience rating has declined significantly over time. Experience rating was originally designed to allocate the cost of UI benefits to employers responsible for the unemployment and to encourage firms to stabilize their employment. These objectives are not being met at the present time. A study by the U.S. Department of Labor suggests that the general degree of experience rating has declined since 1970, and that the financing of benefits has shifted away from a system of individual employer responsibility to a largely socialized system in which all employers share in the costs of unemployment regardless of experience.

The degree of experience rating can be measured by the proportion of effective benefit charges in a state. Effective benefit charges refer to UI benefits paid to former employees that are charged to active employers with positive balances in their reserve accounts (accounts where tax contributions exceed the benefits paid). A study of nine states using the reserve ratio method of experience rating showed that the proportion of effective charges declined from 51 percent in 1970 to 36 percent in 1983 (U.S. Department of Labor, 1985, pp. ii-iii). The remaining benefits either were charged to negative balance and inactive employers or not charged at all to employers because of specific exemption by state law or agency procedure (such as disqualifications, overpayments, combined wage claims, and the state's share of extended benefits). The cost of benefits not charged to employers responsible for the unemployment can be viewed as the subsidized or socialized costs of unemployment.

In addition, the amounts of socialized costs are substantial. In 1983 alone, $3.1 billion or 49 percent of the $6.3 billion of total benefits payments in 12 audited states became socialized costs during this one year period. The degree of effective charges for the audited states ranged from a low of 35 percent to a high of 75 percent (U.S. Department of Labor, 1985, p. iii).

Finally, the same study also showed that firms with high unemployment are heavily subsidized by firms with more stable employment. For 1983, an audit of 12 states showed that firms with high unemployment received $1.6 billion of subsidies from firms with low unemployment. Stable industries such as retailing, finance, and services were heavily subsidizing unstable industries such as manufacturing and construction. For example, for each dollar of UI tax contributions collected from construction and manufacturing, about $3.40 in benefits were paid to unemployed workers within those industries (U.S. Department of Labor, 1985, p. iv).

The effectiveness of experience rating has declined because of (1) relatively low maximum tax rates charged to firms, (2) writing off past benefit charges from the benefit payment history used to determine the employer's tax rate, (3) relatively low taxable wages in most states in which only a fraction of total payroll is experience rated, (4) using alternative tax schedules when state UI funds are relatively low which typically levy the greatest increase in taxes on employers with favorable employment records, and (5) noncharging of benefits to certain employers (U.S. Department of Labor, 1985, pp. v-vi).

In summary, high cost employers with negative balances in their reserve accounts are now being subsidized by low cost employers, which results in more unemployment claims being submitted since the cost of additional benefits to the high cost firms is relatively low.

Contestment of Claims by Employers

Another problem with experience rating is that low cost employers have a financial incentive to contest some legitimate claims to prevent the claims from being charged to their reserve accounts. However, high cost firms with negative balances in their reserve accounts generally have less financial incentive to contest a claim. Once a high cost firm pays the maximum tax rate allowed by law, the marginal cost of laying off additional workers is zero since the additional benefits do not result in higher tax rates. Thus, because of the subsidy received from low cost firms, high cost firms may have less financial incentive to contest claims or stabilize their employment. The U.S. Department of Labor study found that firms paying maximum UI tax rates were less likely to file benefit appeals than firms paying less than the maximum rate (U.S. Department of Labor, 1985, p. 31). This suggests that some negative balance employers that pay maximum tax rates have little or no financial incentive to contest improper claims or to stabilize their employment.

Reduction in Real UI Benefits

Another defect is the reduction in real UI benefits over time, which increases the degree of economic insecurity experienced by unemployed workers. Table 5 indicates the decline in real benefits (1987 constant dollars) for fiscal 1978 and 1987. Average real per capita benefits declined from $2,647 in 1978 to $1,965 in 1987, or a sharp decrease of about 26 percent (see Table 5).

The decline in real benefits can be explained by tighter eligibility and administrative requirements, reductions in the maximum duration of benefits in some states, greater difficulty in collecting benefits under the extended benefits program for workers who have exhausted their regular benefits, unwillingness of many states to liberalize UI benefits because of drawing down or insolvency of state reserve accounts during the 1981-82 recession, and employer resistance to benefit increases because of higher labor costs.

Decline in the Effectiveness of UI as an Automatic Stabilizer

Another defect is that the counter-cyclical impact of unemployment insurance as an automatic stabilizer has declined substantially over time. Unemployment insurance benefits act in a powerful counter-cyclical manner to moderate business recessions. However, a recent study by Gary Burtless indicates that the counter-cyclical effects of unemployment insurance are about 40 percent less than the earlier stimulus provided throughout the 1960s and 1970s (Burtless, 1987, pp. 124-35). Burtless argues that the reduced counter-cyclical effects can be explained by at least three reasons. First, about 25 percent fewer unemployed are collecting benefits than should be expected based on historical experience. Second, the counter-cyclical effects provided by the extended benefits program have been significantly reduced, since the IUR is no longer a reliable trigger mechanism for triggering extended benefits during a severe recession. Finally, the taxation of UI benefits makes them 15 to 20 percent less valuable than they used to be in 1978 and earlier (Burtless, 1987, pp. 124-25).

Improving Unemployment Insurance Programs

Substantial improvements and changes are needed in unemployment insurance programs in order to provide greater economic security to unemployed workers. As noted earlier, the most glaring defect at the present time is the relatively small number of unemployed workers who receive unemployment benefits. If relatively more unemployed workers are to receive benefits, substantial amounts of new revenue must be found. Thus, the most important and critical recommendation is to improve the funding of UI programs.

Increase the Taxable Wage Base

The federal taxable base in 1989 is 6.2 percent on the first $7,000 of annual earnings paid to each covered worker. Except in four states, the UI tax is paid entirely by employers. Employers can credit towards the federal tax any contributions paid under an approved state unemployment insurance program and any tax savings under an approved experience rating plan. The maximum employer credit is limited to 5.4 percent. Because of a desire to strengthen their unemployment reserves, the majority of states have a taxable wage base in excess of $7,000. However, although the state's taxable wage base may exceed the federal wage base, the state wage base is fairly close to the federal base. In 1989, although 35 states had a taxable wage base in excess of $7,000, only 17 states were above $10,000 (U.S. Congress, 1989, pp. 461-62).

The taxable wage base is not automatically indexed to keep up with increases in wages. The result is that taxable wages as a percentage of total wages have declined nationally from 98 percent in 1939 to 33 percent by the end of March 1988 (U.S. Congress, 1989, p. 464).

The federal taxable wages base should automatically be indexed to increase with average annual wages in the national economy. If the taxable wage base had been indexed to reflect the increase in wages since 1947, the current wage base would be $22,097 instead of $7,000 (U.S. Congress, 1989, p. 462).

Increasing the taxable wage base has three major advantages. First, state UI programs will be more adequately financed to pay benefits during a severe recession without having to borrow from the federal government. Second, a higher taxable wage base reduces the inequities in financing that now exist since high wage employers are taxed only on a small fraction of total payrolls, while lower wage employers often pay UI taxes on 80 percent or more of total payroll. Thus, a higher wage base would force high wage employers to pay a relatively larger share of total benefit costs. Finally, a higher wage base increases the effectiveness of experience rating. A higher wage base increases the range over which experience rating can be applied and allows a more meaningful differentiation among employers.

Increasing the Effectiveness of Experience Rating

Another important recommendation is to increase the effectiveness of experience rating. Experience rating can be improved by increasing sharply or even eliminating the maximum UI contribution rate. Alternatively, the maximum taxable wage base could be increased so that a large percentage of total payroll is subject to experience rating. As a result, the subsidy received by high cost firms under the present system would be reduced or even eliminated. Cyclical and seasonal firms and other heavily subsidized firms would then have a greater financial incentive to stabilize their employment since the marginal cost of laying off additional workers would be sharply increased. All other factors equal, greater stability of employment will result in fewer UI claims.

Eliminate the State IUR Trigger for Extended Benefits

Another worthwhile suggestions to increase the proportion of unemployed workers who receive unemployment benefits is to eliminate the state IUR trigger for extended benefits. As noted earlier, the state IUR now used to trigger extended benefits in a state is badly flawed since it does not accurately measure local labor market conditions or the severity of long-term unemployment within a state. The state IUR also is difficult to calculate and explain to workers as a triggering mechanism for extended benefits. Eligibility for extended benefits could be based on more appropriate measures such as the total unemployment rate in the state or the unemployment rate in cities within the state that have unusually high unemployment rates. Alternatively, the governor could be authorized to activate the program in those areas within the state with high unemployment (Subcommittee on Human Resources, 1989).

Although the preceding recommendations will improve the adequacy of funding and increase the proportion of unemployed workers who receive benefits, the increased financing burden would fall largely on employers. Employers undoubtedly will strongly oppose any liberalization of existing UI programs if their labor costs are substantially increased. Estimated 1988 average UI tax rates as a percent of taxable wages and total wages are, respectively, 2.4 percent and 1.0 percent (U.S. Congress, 1989, p. 461). Although these rates alone do not appear excessively high, employers may perceive them as oppressive when OASDHI payroll taxes and workers' compensation premiums (based on payroll) are also taken into consideration.

Many large corporations are carefully examining their labor costs and are reducing the size of their labor force by restructuring. It is unrealistic to assume that large corporations will support needed improvement in UI programs if their labor costs are substantially increased. In addition, smaller firms with stable employment typically subsidize employers in declining industries with large layoffs and high unemployment. Such socialization of the cost of unemployment unfairly penalizes smaller employers with stable employment and rewards larger firms with high levels of employee turnover (U.S. Congress, 1987b, p. 264). It is also unrealistic to assume that smaller employers will support needed improvements in UI programs when their financial burdens are likely to be increased significantly as a result.

Finally, most states are heavily committed to economic development within the state. State governors and legislators are extremely sensitive to the total tax burden and business environment and generally are opposed to increased employer taxes that would dissuade new employers from locating in the state.

Therefore, if a higher proportion of unemployed workers is to receive UI benefits, substantial amounts of new revenues are necessary. The additional revenues realistically can only be obtained from one source--the employees. As a tradeoff for the employee contributions, the states would be required to ease the eligibility and disqualification provisions so that more unemployed persons can receive benefits.

Require Employee Contributions

Only four states now require covered employees to contribute to UI programs (Alabama, Alaska, New Jersey, and Pennsylvania). The major arguments advanced earlier against employee contributions are that (1) employees have no control over their unemployment, (2) labor unions oppose employee contributions since take-home pay is reduced, (3) employers may experience greater labor union demands for higher wages if the employees are required to contribute, and (4) as experience rating developed, it was considered undesirable to have a similar system for employees (Rejda, 1988, p. 329).

However, a strong case can be made for requiring employees to contribute to UI programs in view of the substantial amounts of new revenues that are needed to finance the programs and employer resistance to increased taxes. In the following section, the economic effects of employee contributions to state UI programs and the desirability of employee contributions are examined in some detail.

Economic Impact of Employee UI Tax Contributions

Effect on the Supply of Labor

Requiring employees to contribute to UI programs can affect the supply of labor. The labor supply response depends on the substitution and income effects. Imposing an UI tax on employees reduces the real wage rate. The reduction in the real wage rate decreases work incentives because of the substitution effect: workers tend to substitute leisure for work as real wages decline. However, a decrease in the real wage rate also causes real income to decline. A decrease in real income results in an increase in the number of hours worked because of the income effect. Thus, the substitution and income effects work in opposite directions and create an ambiguity in predicting how the supply of labor will change in response to a UI tax contribution by employees. The actual labor supply response depends on the interaction and relative strength of the substitution and income effects. If the substitution effect is dominant, workers will respond to a reduction in real wages by decreasing the supply of labor. However, if the income effect is dominant, workers will respond to a reduction in real wages by increasing the supply of labor.

The labor supply response to employee UI tax contributions may be different for males than for females. Empirical studies indicate that the male labor supply is much less sensitive to wage changes than is the female labor supply. One empirical study showed that a 10 percent increase in male wage rates would decrease the amount of labor supplied by males by approximately 1 to 2 percent. However, another study showed that a 10 percent increase in wages would increase the hours of work of married women by about 10 percent (McConnell and Brue, 1989, pp. 28-29). Thus, for male workers, UI tax contributions probably would have little or no effect on the number of hours worked (income effect dominates). Since most male workers work full-time, they are not likely to reduce the number of hours worked if a UI tax contribution is required.

However, the labor supply response may be different for married women. As noted earlier, empirical studies suggest that married women are more sensitive to wage increases or decreases than men. Thus, UI tax contributions probably would have a much greater impact on married women workers. Many married women work only part-time, and UI tax contributions may result in a reduction in the number of hours worked (substitution effect is dominant). Married women who work would have a greater tendency to substitute leisure or work in the home for work in the labor market when UI tax contributions are imposed.

In conclusion, a new UI tax contribution by employees would have little if any effect on the number of hours worked by full-time male workers but may cause a reduction in the number of hours worked by female workers, especially married women who work only part-time.

Incidence of UI Tax Contributions

Economists generally agree that all payroll taxes paid by employers are shifted to the workers as a group in the long run in the form of lower wages or higher product prices. Traditional Keynesian economics states that the aggregate labor supply curve is perfectly intelastic in the long run; that is, workers will not respond to a small UI payroll tax contribution by reducing the quality of labor supplied. However, many economists believe that the labor supply curve may be somewhat elastic rather than perfectly inelastic. Because of ambiguity between the income and substitution effects, the slope of the overall labor supply curve still remains controversial. In this analysis, two possible economic scenarios are discussed with respect to the elasticity of labor supply.

Perfectly Inelastic Supply Curve. In this case, the overall labor supply curve is assumed to be perfectly inelastic, which indicates that workers will not respond to a UI tax contribution by reducing the collective quantity of labor supplied. Figure 1 demonstrates the traditional analysis and conclusions concerning the question of who actually bears the burden of the UI tax. The curve labeled [D.sub.1] in Figure 1 is the conventional labor demand curve or marginal revenue product (MRP) curve. The pretax equilibrium wage is at w*, and the equilibrium quantity of labor hired in [Q.sub.1]. Let us next assume that the employer must pay a UI tax on the pretax equilibrium wage, w*. The tax increases the firm's labor costs. Because the true MRP of labor is now the initial MRP minus the UI tax, the demand curve after the tax is imposed shifts downward to [D.sub.2]. Although the firm must pay an hourly tax equal to the vertical distance from [D.sub.1] to [D.sub.2] for each labor hour employed, the effective MRP is only [w.sub.1] (which is equal to the market wage rate after the employer's contribution). Thus, employees as a group pay the employer's UI tax in the long run in the form of a lower wage, [w.sub.1].

Also assume that the employees are now required to pay a UI tax on the full pretax wage. Curve [D.sub.3] shows the after-tax wage, which is calculated by subtracting the employee's UI tax contribution from [D.sub.2]. Thus, the worker's net hourly wage is [w.sub.2]. The UI payroll tax reduces the employeehs market wage from w* to [w.sub.1] and the actual after-tax wage from w* to [w.sub.2]. On the surface, it appears that the employee pays only a tax as measured by the vertical distance from [D.sub.2] to [D.sub.3]. However, in reality, the employee bears the entire tax as measured by the vertical distance from [D.sub.1] to [D.sub.3].

In conclusion, given a perfectly inelastic supply curve, employees pay not only the employer's UI tax contributions but would bear the burden of a new employee tax as well.

Elastic Supply Curve. In reality, the labor supply curve is elastic. Workers are willing to work more hours at higher wages and fewer hours at lower wages. If the employees are required to contribute to the UI program, married spouses, teenagers, retired workers, and other workers who do not have a strong attachment to the labor force may reduce their supply of labor. Figure 2 shows an elastic labor supply curve which implies that workers collectively will respond to a wage or tax change by adjusting the amount of labor supplied. [D.sub.1] is the demand schedule for labor, and [S.sub.1] is its supply schedule. Initial equilibrium is at [E.sub.1] with a labor supply of [Q.sub.1] and a wage rate of [w.sub.1]. Introduction of an employer UI tax contribution reduces the demand curve for labor from [D.sub.1] to [D.sub.2]. The vertical distance from [D.sub.1] to [D.sub.2] represents the employer's UI tax contribution. With a new equilibrium [E.sub.2], the market wage rate is [w.sub.2], and the quantity of labor supplied is [Q.sub.2]. Since the workers are faced with a lower wage rate, they bear part of the employer's tax contribution (the vertical distance from [w.sub.1] to [w.sub.2]), and the employer bears only a part of the contribution (vertical distance from [w.sub.2]' to [w.sub.1]). Now assume that the state also requires the employees to contribute to the UI program. Introduction of a new UI employee tax raises the supply schedule facing the employer from [S.sub.1] to [S.sub.2]. The vertical distance from [S.sub.1] to [S.sub.2] represents the employee's contribution. With both taxes in place, equilibrium shifts to [E.sub.3]. At the new equilibrium point, [E.sub.3], the market wage rate rises to [w.sub.3], the net (after both taxes) wage falls to [w.sub.3]', and the supply of labor is reduced to [Q.sub.3]. The total tax equals the vertical distance from [w.sub.3]' to [w.sub.3]", with [w.sub.3]-[w.sub.3]' collected from the employee and [w.sub.3]-[w.sub.3]" collected from the employer. The employee still bears part of the employer's tax contribution ([w.sub.1]-[w.sub.3]). From this analysis, one can conclude that if the elasticity of demand for labor is greater than the elasticity of the supply of labor (i.e., the slope of the labor demand curve is flatter than that of the labor supply curve), then the employees will bear part of the employer's contribution if the same tax rate is imposed on both the employer and employees.

In conclusion, UI tax contributions by employers result in a decrease in the demand for labor and a reduction in the market wage rate. Requiring employees to contribute will result in an additional reduction in the quantity of labor demanded and a reduction in the real wage rate.

Public Policy Implications and Conclusions

Although UI tax contributions by employees can significantly increase the proportion of unemployed workers who receive benefits and improve the solvency of state unemployment reserve accounts, a new payroll tax on employees presents several serious problems. First, based on the economic analysis discussed earlier, the burden of the employer's tax contribution falls on the workers in the long run in the form of lower wages. In the case of a perfectly inelastic labor supply curve (Figure 1), workers as a group would bear the entire financial burden of employee and employer UI tax contributions. If the states do not relax the eligibility requirements and disqualification provisions to make it easier for unemployed workers to receive benefits, the workers would have to pay a new payroll tax without any corresponding benefits. In addition, if the states impose a new UI payroll tax on employees and at the same time reduce the employer's contribution rates, unemployed workers, on balance, would not be helped.

Second, if the economy is faced with an upward sloping elastic supply curve (Figure 2), then imposition of a new UI payroll tax on employees would result in a reduction in the level of employment and also a reduction in the real wage rate. Thus, the output level or national income will decrease. In addition, in the case of a perfectly intelastic supply curve, real wages will also decline if the employees are required to contribute. Consequently, the deflationary effects of a new payroll tax must be carefully evaluated before the employees are required to contribute to UI programs.

Finally, a new UI payroll tax does not consider the worker's ability to pay and would fall heavily on the working poor who may be earning only minimum wages. An additional payroll tax would make it more difficult for the working poor to escape from poverty.

Despite these problems, however, several positive advantages would result from the imposition of a UI payroll tax on employees. First, and most important, a larger proportion of unemployed workers would receive benefits, and economic insecurity from unemployment would be substantially reduced. The fundamental social insurance principle of paying UI benefits to large numbers of involuntarily unemployed workers would be properly restored.

Second, employee UI tax contributions would improve the financial solvency of state unemployment accounts. As noted earlier, most states have inadequate reserves for paying UI benefits during severe recessions without having to borrow from the federal government.

Third, employee contributions may reduce the financial incentive of some firms to contest legitimate claims, which will make it easier for some unemployed workers to qualify for benefits.

Further, the effectiveness of unemployment insurance as an automatic stabilizer would be significantly improved. Additional workers would receive benefits during recessions. The marginal propensity to consume (MPC) generally is higher for unemployed workers than for workers who are employed, and the marginal propensity to save (MPS) is smaller. Since the multiplier is the reciprocal of the MPS, the positive multiplier effect of UI benefits would be substantially increased because of the additional number of unemployed workers who are receiving benefits and the higher multiplier effect. As a result, all things equal, UI benefits would be more effective in moderating severe recessions than is now the case.

Finally, employees would have greater interest in state UI programs if they were required to contribute. The public generally is ignorant and confused concerning the nature, goals, and objectives of state UI programs. In many cases, unemployed workers are not even aware that they are eligible for UI benefits. For example, a sample of household heads in the Mathematica study indicated that about 15 percent either believed or did not know whether they were eligible for UI benefits. Most of this group (81 percent) did not even apply for benefits (Mathematica Policy Research, 1988, p. 115). If employees were required to contribute, there would be greater awareness of the availability of UI benefits. Thus, a higher proportion of unemployed workers could be expected to apply for benefits.

References

[1] Brechling, Frank, 1977, "Unemployment Insurance Taxes and Labor Turnover: Summary of Theoretical Findings," Industrial and Labor Relations Review, 30: 483-492.

[2] Burtless, Gary, 1987, "The Adequacy and Counter-Cyclical Effectiveness of the Unemployment Insurance System," Reform of the Unemployment Compensation Program, Hearing Before the Subcommittee on Public Assistance and Unemployment Compensation of the Committee on Ways and Means, House of Representatives, 100th Cong., 1st Sess. (Washington, D.C.: Government Printing Office), pp. 124-135.

[3] Center on Budget and Policy Priorities, 1988, Uncovered: Unemployment Insurance and Jobless Workers in 1987 (Washington, D.C.: Center on Budget and Policy Priorities).

[4] Feldstein, Martin, 1976, "Temporary Layoffs in the Theory of Unemployment," Journal of Political Economy, 84: 937-957.

[5] Halpin, Terrance C., 1980, "Employment Stabilization," Unemployment Compensation: Studies and Research, Vl. 2 (Washington, D.C.: National Commission on Unemployment Compensation).

[6] Kingston, Jerry L., Paul L. Burgess, and Robert D. St. Louis, 1986, "Unemployment Insurance Overpayments: Evidence and Implications," Industrial and Labor Relations Review, 39: 323-336.

[7] Mathematica Policy Research, Inc., 1988, An Examination of Declining UI Claims During the 1980s (Princeton, New Jersey: Mathematica Policy Research, Inc.).

[8] McConnell, Campbell R. and Stanley L. Brue, 1989, Contemporary Labor Economics, 2nd ed. (New York: McGraw-Hill Book Company).

[9] Musgrave, Richard A. and Peggy B. Musgrave, 1985, Public Finance in Theory and Practice, 4th ed. (New York: McGraw-Hill Company).

[10] Myers, Robert J., 1985, Social Security, 3rd ed. (Homewood, Illinois: Richard D. Irwin, Inc.)

[11] National Commission on Unemployment Compensation, 1980a, Unemployment Compensation: Final Report (Washington, D.C.: National Commission on Unemployment Compensation).

[12] National Commission on Unemployment Compensation, 1980b, Unemployment Compensation: Studies and Research, Vols. 1-3 (Washington, D.C.: National Commission on Unemployment Compensation).

[13] Rejda, George E., 1988, Social Insurance and Economic Security, 3rd ed. (Englewood Cliffs, New Jersey: Prentice-Hall, Inc.)

[14] Rejda, George E. and David I. Rosenbaum, 1988, Unemployment Insurance and Full-Cost Experience Rating: The Impact on Employment, Working Paper No. 88-1070 (Lincoln: Economics Department, University of Nebraska).

[15] Saffer, Henry, 1980, "The Effects of Experience Rating on the Unemployment Rate," Unemployment Compensation: Studies and Research, Vol. 2 (Washington, D.C.: National Commission on Unemployment Compensation).

[16] Subcommittee on Human Resources, Committee on Ways and Means, U.S. House of Representatives, 1989, Press Release, No. 8, April 21.

[17] U.S. Congress, House, Committee on Ways and Means, 1987a, Background Materials and Data on Programs within the Jurisdiction of the Committee on Ways and Means (Washington, D.C.: U.S. Government Printing Office).

[18] U.S. Congress, House, Committee on Ways and Means, 1987b, Reform of the Unemployment Compensation Program, Hearing Before the Subcommittee on Public Compensation and Unemployment Compensation, 100th Cong., 1st Sess. (Washington, D.C.: U.S. Government Printing Office).

[19] U.S. Congress, House, Committee on Ways and Means, 1988, Background Materials and Data on Programs within the Jurisdiction of the Committee on Ways and Means (Washington, D.C.: U.S. Government Printing Office).

[20] U.S. Congress, House, Committee on Ways and Means, 1989, Background Materials and Data on Programs within the Jurisdiction of the Committee on Ways and Means (Washington, D.C.: U.S. Government Printing Office).

[21] U.S. Department of Labor, Office of Audit, 1985, Financing the Unemployment Insurance Program Has Shifted from a System Based on Individual Employer's Responsibility Towards a Socialized System (Washington, D.C.: U.S. Department of Labor, Office of Audit).

[22] U.S. General Accounting Office, 1988, Unemployment Insurance: Trust Fund Reserves Inadequate (Washington, D.C.: General Accounting Office).

George E. Rejda is V. J. Skutt Professor of Insurance and Kyung W. Lee is a Ph.D. candidate in insurance at the University of Nebraska-Lincoln. The authors thank Robert J. Myers for helpful comments.
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Author:Rejda, George E.; Lee, Kyung W.
Publication:Journal of Risk and Insurance
Date:Dec 1, 1989
Words:7164
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