UI: Why It Matters

This is Part 3 of a serial posting of my law review article, “How to Save Unemployment Insurance.” Part One is here, Part Two here. You can download the whole manuscript here.

UI, like other forms of insurance, is a form of income smoothing.[1] In effect, workers accept lower salaries when they have a job in exchange for an income of more than zero when they are out of work.[2] For workers with important fixed expenses, such as the costs of sheltering and feeding their family, having replacement income during spells of unemployment represents an essential lifeline.[3]

It’s generally agreed that if government did not provide UI, private markets would be unable to replace it.[4] Many households also could not replicate the UI lifeline through other forms of saving or borrowing.[5]

Direct government spending, financed out of general revenues rather than through a dedicated UI tax, could provide yet another potential alternative for out-of-work individuals, but the U.S. has gone in exactly the opposite direction. Most of the major benefits state and federal governments offer to needy households are tied to work.[6] And, aside from the premium support credits of the Affordable Care Act, none of these programs offer much assistance to dual-earner lower middle-income households, who might avoid poverty when one earner loses his or her job, but still suffer considerable financial hardship.

In addition to its important role for families, UI is perhaps the most effective fiscal tool governments can use to combat recession.[7] To simplify a bit, a central problem during many recessions is a downward spiral of demand.[8] When some employees lose their jobs, they stop buying things, reducing the need for workers at other workplaces, who in turn stop buying things, and so on. It would be in the collective interest of each worker and each employer to escape recession. The costs of consumption and hiring are borne by each worker and employer, however, while the benefits of their purchases and hiring decisions flow to many other people. In short, during recessions hiring and consumption create significant economic spillovers or “positive externalities.”[9]

Standard modern macroeconomic theory suggests that during recessions government should aim to boost demand by spending money — or, equivalently, by cutting taxes — and in particular by spending in ways that produce the most economic bang for the buck.[10] Dropping money from helicopters might be a useful way to put cash in people’s pockets, but that won’t much help fight recessions if everyone then buries the money in their back yard. Instead, government wants to put cash in the hands of those with the greatest “marginal propensity to spend,” or, more simply, the folks who will buy stuff with their new wealth.[11] If they do so, that can lead to more hiring, resulting in yet more demand, and so on, reversing the downward spiral.[12] Measures of this return on investment are usually called the “multiplier.”[13]

UI has among the largest multipliers of any large-scale government program or tax cut.[14] Households receiving UI will tend to spend, not save, because those households are worse off than they will likely be at other times of their lives.[15] Most estimates find accordingly that government expenditures on UI have multipliers of 1.6 or higher, with some exceeding 2.0.[16] For comparison, corporate tax cuts, such as those enacted by Congress during the 2001 recession, earn multipliers lower than 1.0.[17] Other estimates suggest that UI-driven demand during the recent recession accounted for .8% of GDP, reducing the impact of the recession by about 10% of the downturn on average.[18] There was, though, very significant variation in UI efficacy across states, reflecting the varying local rules for UI administration, as I will detail in a later installment.[19]

Recent research also suggests that UI may contribute to both household well-being and the economy in yet other ways. UI benefits allow workers to spend longer searching for jobs that are the best match for their skills.[20] Similarly, the possibility of a safety net may allow workers to take greater risks, allowing for greater innovation, “intrapreneurship,” (that is, invention within an existing employment relationship), and economic growth.[21] UI systems may help workers maintain an attachment to the workforce and aid them in finding retraining and new job opportunities.[22] And, finally, some unpublished work suggests UI helps to boost credit and credit repayment, which can have important positive spillovers during recessions, like the most recent, in which mortgage defaults are a major driver of economic turmoil.[23]

[1] Jonathan Gruber, The Consumption Smoothing Benefits of Unemployment Insurance, 87 Am. Econ. Rev. 192, 192 (1997); Edi Karni, Optimal Unemployment Insurance: A Survey, 66 S. Econ. J. 442, 443, 447 (1999).

[2] Id. at 447.

[3] CBO, supra note 7, at 9–10; GAO, supra note 12, at 33 (summarizing findings of econometric studies). For example, Professor Gruber reports that, in the absence of UI, household consumption would on average fall three times as far during periods of unemployment. Gruber, supra note 46, at 195.

[4] Gruber, supra note 46, at 192; Karni, supra note 42, at 461.

[5] Gruber, supra note 46, at 192; Nicholson & Needels, supra note 6, at 55.

[6] Kathryn J. Edin & H. Luke Shaefer $2.00 a Day: Living on Almost Nothing in America xxiii, 8–9 (2015).

[7] GAO, supra note 12, at 41, 43–44; Lawrence Chimerine, Theodore S. Black & Lester Coffey, U.S. Department of Labor, Unemployment Insurance as an Automatic Stabilizer: Evidence of the Effectiveness Over Three Decades, Unemployment Occasional Paper No 99–8, at 5–9, 60–79, available at https://oui.doleta.gov/dmstree/op/op99/op_08-99.pdf. Fiscal tools may be especially important in an environment in which the Federal Reserve’s monetary policy options are limited by existing, very low, interest rates. Furman, supra note 14, at 3.

[8] David Romer, Advanced Macroeconomics Ch. 11.3 (4th ed. 2011); N. Gregory Mankiw, Macroeconomics Ch. 18 (9th ed. 2016) .

[9] Id.

[10] Id.

[11] Furman, supra note 14, at 5.

[12] Chimerine, Black, & Coffey, supra note 66, at 12.

[13] Romer, supra note 67, at Ch. 12.7.

[14] GAO, supra note 12, at 41; see generally Alan J. Auerbach & Daniel Feenberg. The Significance of Federal Taxes as Automatic Stabilizers, 14 Journal of Economic Perspectives 37 (2000).

[15] CBO, supra note 7, at 13.

[16] Congressional Budget Office, Policies for Increasing Economic Growth and Employment in 2012 and 2013, at 28 Tbl. 1 (Nov. 15, 2011); Wayne Vroman, The Role of Unemployment Insurance as an Automatic Stabilizer During a Recession 48 (2010).

[17] CBO, supra note 75, at 28 Tbl. 1.

[18] Executive Office of the President, Council of Economic Advisors, The Economic Impact of Recent Temporary Insurance Extensions 5 (Dec. 2, 2010); Vroman, supra note 75, at 45–49.

[19] Vroman, supra note 75, at 49–51. The U.S. UI system has also been less effective in the recent past than systems in other countries. Mathias Dolls, Clemens Fuest, & Andreas Peichl, Automatic stabilizers and economic crisis: US vs. Europe, 96 J. Pub. Econ. 279, 279–294 (2012).

[20] Arash Nekoei & Andrea Weber, Does Extending Unemployment Benefits Improve Job Quality?, 107 Am. Econ. Rev. 527 (2017); Chetty, supra note 53, at 174.

[21] See generally Daron Acemoglu & Robert Shimer, Productivity Gains from Unemployment Insurance, 44 European Economic Review 1195 (2000).

[22] Furman, supra note 14, at 3, 6; Chimerine, Black, & Coffey, supra note 66, at 42.

[23] Joanne W. Hsu, David A. Matsa, & Brian T. Meltzer, Positive Externalities of Social Insurance: Unemployment Insurance and Consumer Credit, NBER Working Paper №20353 (July 2014).