Saving Unemployment Insurance
A Serial in Several Parts
Over the next week or so, I’ll be serializing parts of a new draft on the financing of the U.S. unemployment insurance system. It’s a story of federalism, political short-sightedness, and the unhappy marriage of the two. You can read the whole thing here.
Introduction
Unemployment insurance (“UI”) is a key pillar of modern economies. In addition to serving as a vital safety net for working families, UI provides major counter-cyclical support for the economy during economic downturns, helping to reverse a recession’s downward spiral of falling demand and additional layoffs.[1] Experience during the Great Recession, however, shows that the American UI system is crumbling, perhaps near collapse.[2] For all that UI benefits helped — estimates suggest they may have prevented as much as 10% of the damage from the slowdown — other features of the UI system were actually working to discourage new hiring.[3] And it is likely that developments over the past few decades crippled the UI benefit system, leaving it far less effective than it might have been, and worsening the nation’s recent economic woes.[4]
This Article attempts to diagnose UI’s failures and to provide some possible paths forward. While UI has received scant attention in legal academia,[5] and its financing system essentially zero attention, there is a general awareness in the policy community that something went badly wrong in 2009 and 2010.[6] My argument here will be that existing proposals for UI reform, while often thoughtful and worthy of serious consideration, have missed several important likely causes of UI’s failures. I show that these proposals remain vulnerable to the same failings that have lead UI to the brink, and offer instead some modifications to better reflect UI’s underlying weaknesses.
One particularly important oversight is that existing proposals neglect the significant role of fiscal myopia, or the tendency of state-level actors to behave short-sightedly when setting state budgets. Most UI benefits are paid for through state taxes on local businesses.[7] State actors both rationally expect to leave office or relocate before long-term investments pay off, and also may lack the personal or institutional willpower to sacrifice today for the benefit of tomorrow.[8] Proposed reforms almost exclusively provide states with ex post (that is, delayed) incentives to save for future UI demands, and these incentives are likely to be ineffective in influencing myopic officials.[9] In contrast, I suggest ex ante reforms that would exploit state-official myopia in a way that encourages greater savings, such as by paying states to commit now that future state officials will begin saving.
In crafting my suggestions I draw on important recent theoretical and empirical work in behavioral economics.[10] Even if state officials are rationally myopic, I will argue, policy tools that have been developed to counter irrational myopia among individuals can readily be adapted for use in fiscal policy. In addition to current payments for future commitments, I also propose using opt-out defaults as a way of steering state officials to make the best choices, and explain why these defaults may be preferable to alternatives such as penalties or subsidies.
Another major difficulty with both UI law and proposed reforms is that they tend to incentivize states to cut benefits, even when further benefit cuts would tend to be bad for the country as a whole.[11] UI’s financing system encourages states to accumulate money in a trust fund account when times are good, so that there is enough money available to pay benefits during recessions when benefit claims spike.[12] Unfortunately, all of the existing tools for encouraging positive trust fund balances allow states to choose whether to improve their financial condition by raising taxes, or instead by cutting back on promised benefits.
Many systematic features of law and politics put pressure on states to choose benefit cuts — including, as no one has apparently observed before, the fact that the federal government effectively taxes states on their benefit payments. As a result, the share of separated workers who receive UI benefits has fallen from more than 45% to less than 30%.[13] Other developed countries average more than double that rate.[14] This implies that, had UI been as robust as it was in the past, the most recent recession could have been softened by perhaps 15% or more, not 10%.
I propose mechanisms that aim to reverse these unwanted incentives for benefit cutting. Among other suggestions, I offer the possibility that any incentives a state is offered depend not on the proportion of its own promised benefits the state holds in its trust fund, as in current law, but instead on the per capita fraction of total national benefits the state’s fund could afford to pay. The power of this measure, which I dub the “population-adjusted revenue target,” or PART, is that no individual state could significantly change its PART by cutting benefits; only revenue increases would do. Of course, there are a number of plusses and minuses to such a scheme, as I discuss. In addition, I argue that a simpler step, repealing the effective federal tax on state benefits, would help remove the federal distortions that currently favor benefit trimming.
If I am correct that ex ante incentives are critical to successful UI reform, it is important that policy makers consider fixes to the UI system now, while the economy is still steady.[15] The next recession will be too late to enact many of the most promising policies. For example, states that run out of trust fund money can borrow from the federal government.[16] Forgiving these state debts in exchange for state commitments is one of the few major ex ante incentives available to the federal government. If Congress were to forgive future debt without exacting the right kinds of promises from states, it will have squandered a relatively unique opportunity. And, in the meanwhile, states continue to cut UI benefits — when North Carolina recently announced that it would shorten the maximum period of benefits, several other states followed.[17]
Part I of the Article offers a general introduction to unemployment insurance and its financing in the United States. Part II describes UI’s path to near-collapse during the Great Recession. These two initial sections will be familiar to other scholars who study UI. Part III offers my account of the underlying causes of the events described in Part II. Part IV then assesses existing proposals for UI reform in light of these fundamental problems, and argues that none adequately account for myopic state officials. Part V proposes a series of new potential reforms, and weighs their accompanying tradeoffs.
[1] U.S. Department of Labor, Office of Unemployment Insurance, Division of Legislation, Unemployment Compensation: Federal-State Partnership 1 (2017); Congressional Budget Office, Letter to the Hon. Jim McDermott, Unemployment Insurance Benefits and Family Income of the Unemployed, at 6–11 (Nov. 17, 2010); Walter Nicholson & Karen Needles, Unemployment Insurance: Strengthening the Relationship Between Theory and Practice, 20 J. Econ. Perspectives 47, 48 (2006).
[2] Michael Leachman et al., Rebuilding the Unemployment Insurance System: A Deficit-Neutral Plan That Limits Tax Increases and Maintains Benefits, National Employment Law Project, at 1 (Feb. 9. 2011) (“The systems for financing unemployment insurance…in many states are broken….”); Andrew Stettner, The Century Foundation, Speeding the Recovery of Unemployment Insurance, Mar. 29, 2016, at 2, 5–6 (“The UI system faces a funding crisis that has made the safety net weaker than any time in its history.”).
[3] See infra Part II.B.
[4] See infra part II.A.
[5] The only prior discussion of the UI financing system I could identify in the legal literature was Symposium, Unemployment Insurance: Continuity, Change, and Prospects for Reform, 29 U. Mich. J. Reform 1 et seq. (1995–1996). Other legal scholarship addresses the role of UI taxes as an incidental aspect of UI’s role in society more generally. Gillian Lester, Unemployment Insurance and Wealth Redistribution, 49 UCLA L. Rev. 335 (2001); Frans Pennings & Paul M. Secunda, Towards the Development of Governance Principles for the Administration of Social Protection Benefits: Comparative Lessons from Dutch and American Perspectives, 16 Marquette Benefits & Soc. Welfare L. Rev. 313, 392–93 (2015).
[6] Recognition that the UI system has serious flaws predates the Great Recession, as summarized in Advisory Council on Unemployment Compensation, Collected Findings and Recommendations: 1994–1996 (1996) [hereinafter “ACUC”] and GAO, Unemployment Insurance: Program’s Ability to Meet Objectives Jeopardized, GAO/HRD-93–107 (Sept. 1993).
[7] Congressional Budget Office, Unemployment Insurance in the Wake of the Great Recession, CBO Pub. №4525, at 5 (Nov. 2012).
[8] Brian Galle & Kirk Stark, Beyond Bailouts: Federal Tools for Preventing State Budget Crises, 87 Ind. L.J. 599, 608–09 (2012).
[9] See infra text accompanying notes 161–179.
[10] For overviews, see generally Brian Galle, Tax, Command … or Nudge? Evaluating the New Regulation, 92 Tex. L. Rev. 837 (2014) and Brigitte C. Madrian, Applying Insights from Behavioral Economics to Policy Design, 6 Ann. Rev. Econ. 663 (2014).
[11] ACUC, supra note 6, at 12.
[12] United States Government Accountability Office, Unemployment Insurance: States’ Reduction in Maximum Benefit Duration Have Implications for Federal Costs, GAO-15–281, at 10–11 (Apr. 2015).
[13] U.S. Department of Labor, Unemployment Insurance Chartbook, Regular Program Insured Unemployment as a Percent of Total Unemployment, 1950–2016, https://oui.doleta.gov/unemploy/Chartbook/a12.asp (last visited June 28, 2017); Laurie J. Bassi & Daniel P. McMurrer, Coverage and Recipiency: Trends and Effects, in Unemployment Insurance in the United States: Analysis of Policy Issues 51, 52, 63 (Christopher J. O’Leary & Stephen A. Wandner eds., 1997).
[14] Wayne Vroman, Unemployment Insurance: Current Situation and Potential Reforms, at 3 n.1 (unpublished manuscript, Feb. 3, 2009).
[15] See Jason Furman, U.S. Council of Economic Advisors, The Economic Case for Strengthening Unemployment Insurance, at 1 (July 1, 2016) (“ Unfortunately, people often only pay attention to these issues at the wrong time: in the middle of a recession …. Instead, it is a discussion we should be having now while the labor market is strong.”).
[16] U.S. Department of Labor, supra note 1, at 7.
[17] GAO, supra note 12, at 4–5.

