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Unemployment insurance.

"Unemployment Insurance Experience-Rating and Labor Market Dynamics," by David D. Ratner. January 2014. SSRN #2376364.

Readers of Regulation likely are familiar with the work of University of Chicago economist Casey Mulligan about the role that the incentive effects of transfer payments played in increasing the unemployment rate during the Great Recession and its aftermath. This paper makes similar arguments about the role of experience-rating in unemployment insurance.

Unemployment insurance benefits are paid for by taxes on employers set by the states. The taxes are not fully experience-rated; that is, employers with a high rate of layoffs do not pay taxes sufficient to cover the benefits for their discharged employees, while employers with a low rate of layoffs pay taxes that are larger than the benefits received by their discharged employees. The degree of experience-rating varies across states and thus the marginal tax on employers for layoffs varies across states.

In this paper, Federal Reserve Board economist David Ratner utilizes the variance in experience rating across states to calculate the effect of increased experience-rating. The average state marginal tax cost of a layoff to employers (the present discounted value of benefits paid back in future higher taxes) is 54 percent of the benefits paid to a firm's employees. Job reallocation (the sum of job creation and job destruction) falls linearly as the marginal cost to employers of a layoff increases. Job destruction goes down because employers understand that layoffs increase future unemployment taxes. Job creation also decreases because employers anticipate the possibility of layoffs and subsequent higher taxes when they hire someone. Ratner concludes that increasing experience-rating by 5 percent would decrease layoffs by 2 percent but decrease job creation by 1.5 percent, resulting in a net decrease in unemployment of 0.21 percentage points. However, if the system were fully experienced-rated and employers paid 100 percent of the costs of the benefits to a laid-off employee, job destruction would decrease by 17 percent while job creation would decrease by 13.7 percent, resulting in a net increase in employment.

The Great Recession has resulted in a debt of $20 billion that the state unemployment trust funds must pay back to the federal government. Ratner demonstrates that if those funds are repaid through an increase in experience rating, unemployment will decrease because of better incentives. In contrast, if the debt is repaid through a flat-rate tax increase with no change in experience-rating, unemployment would increase because of the perverse incentives on employers.

PETER VAN DOREN is editor of Regulation and a senior fellow at the Cato Institute.

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Author:Van Doren, Peter
Geographic Code:1USA
Date:Mar 22, 2014
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